President-elect Joe Biden’s promise to tax the wealthy may include a tax on dividends, something made easier now that Democrats hold the House and the slimmest majority possible in the Senate.

The Biden administration has called for those making more than $1 million to pay the same rate on investment income that they do on their wages. Investment income includes dividends and capital gains.

But an earlier Biden plan for financing health-care initiatives indicates the new president will tax long-term capital gains and qualified dividends at the new top ordinary income tax rate of 39.6% on income above $1 million and eliminate the step-up in basis that allows decedents to pass capital gains to heirs without taxes.

That means the top rate on long-term capital gains would nearly double from 23.8% to 43.4%. Biden’s campaign cites a Joint Committee on Taxation report on tax expenditures which estimates that the special lower rate on capital gains and dividends reduces federal revenue by $127 billion each, according to Scott Eastman, a policy analyst at the Tax Foundation, an independent tax policy nonprofit.

The change would have a significant tax impact on wealthy investors. “We estimate the plan would increase the average tax rate on capital gains from 19.1% to 27.7%, and the marginal tax rate on capital gains from 22.4% to 33.4%,” Eastman said.

While the revenue estimate implies that the government loses a lot of revenue from the lower rate on capital gains, it is “highly unlikely” the federal government could get this much revenue from just raising the rate, Eastman cautioned. 

Research from the Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) shows that taxpayer capital gains realizations are very sensitive to taxation.

“This is because taxpayers can time when they want to realize their capital gains in order to minimize their tax bills,” Eastman said. “Specifically, the CBO and JCT estimate that the elasticity of realizations to the tax rate is -1.2 in the short run and -0.79 in the long run. Specifically, a 1% increase in the capital gains tax rate would result in a 0.79 to 1.2% drop in capital gains realizations.

“In practice, this means that proposals to significantly raise capital gains tax rates, with no other changes, can lose federal revenue,” he added. “Using CBO data on capital gains realizations and these elasticities, we estimate that raising the top rate to 43.4% could lose about $2 billion each year.”

Eastman said he arrived at that top rate by combining the 39.6% statutory rate plus the 3.8% net investment income tax.

However, Biden is not simply proposing to raise the top rate on capital gains. He also proposes eliminating step-up basis in capital gains. According to the JCT, not taxing gains at death results in an annual loss of about $40 billion.

Again, this is a tax expenditure estimate and not a revenue estimate, and the amount of revenue Biden’s proposal would ultimately raise would depend on how he structures the elimination of the step-up in basis, Eastman said.

Biden “could require heirs to take on the decedent’s basis when they receive an asset, known as carryover basis, but still allow heirs to defer realization of that inherited asset’s capital gain,” Eastman said. “This would raise much less than making death a taxable event—and even then, proposals to tax capital gains at death can have many exemptions.”

It is also important to note how the two proposals interact. “Since Biden is raising the tax rate on capital gains, the value of the tax expenditure for step-up in basis will mechanically increase. This is because the rate at which these gains would otherwise be taxed at would be higher,” Eastman said.

In addition, eliminating step-up in basis at death reduces a taxpayers’ incentive to defer realizing gains. Part of the reason why there is such a strong incentive to defer the tax on capital gains is that if an individual defers long enough, the tax on the asset will eventually be forgiven, Eastman said.

Without step-up in basis, a taxpayer has a greater incentive to realize the gain during their lifetime. As such, eliminating step-up in basis can indirectly boost revenue from capital gains.

While the plan will raise additional federal revenue in a progressive manner, it isn’t costless. Raising taxes on capital gains would reduce the incentive to save by reducing the after-tax return to saving.

“Lower domestic saving leads to lower income for Americans in the future and can lead to lower output by reducing domestic investment,” Eastman said. “In addition, there are administrative, structural and transition issues that Biden needs to consider if he ultimately eliminates step-up in basis,”

While it is premature to make predictions about what Biden and his Democratic-majority Congress will do, Biden has stated plainly that he wants to raise tax revenues by $3.3 trillion over the next decade.

“On a conventional basis, the Biden tax plan by 2030 would lead to about 7.7% less after-tax income for the top 1% of taxpayers and about a 1.9% decline in after-tax income for all taxpayers on average,” according to Tax Foundation analysis.

In addition to the potential new tax rates for those earning $1 million or more, Biden’s plan also seeks to impose a 12.4% Social Security payroll tax on income earned above $400,000, evenly split between employers and employees. This would create a “donut hole” in the current Social Security payroll tax, where wages between $137,700, the current wage cap, and $400,000 are not taxed.