[Editor's Note: This article was written almost five weeks ago in mid-March. Why markets were so surprised yesterday by the White House confirming it would seek to raise capital gains taxes dramatically, as it had promised, remains uncertain.]
In his first 50 days in office, President Biden failed to mention the words “higher taxes” in his first 50 days in office. That changed on St. Patrick's Day.
The hesitancy may be explained by the presiden's focus on ending the pandemic and jump-starting a recovery. But so far Biden shares one common characteristic with his predecessor—a remarkable degree of commitment to follow through on his campaign pledges.
One of these promises could exert a powerful effect on the financial markets. Biden has said he would raise the capital gains from its current 20% rate for high-earners to the ordinary income rate of 39.6%, or 43.4% including a surcharge for ultra-high earners. Whether it could pass legislation to reach this objective is questionable.
A lookback at recent capital gains tax hikes over the last four decades provides little meaningful evidence of their influence on financial markets. President Reagan raised the capital gains tax rate from 20.9% to 28% as part of the 1986 tax reform legislation. At the time, he reasoned that it was unfair that a millionaire trading stocks could pay a lower rate than a bus driver.
President Obama let the Bush tax cuts expire for those earning more than $400,000 in 2013. For those individuals, their tax rate on capital gains and dividends went from 15% to 20%, or 23% if the taxpayer reached certain threshold outlined within the Affordable Care Act.
The results for stock prices were inconclusive. In 2013, the Standard & Poor’s 500 soared about 33%. In 1987, stocks rocketed more than 45% in the first eight months before tumbling in October of that year.
However, the magnitude of the tax increases on capital gains and dividends that Biden envisions dwarfs the Reagan and Obama tax hikes. Biden previously has said nobody earning less than $400,000 annually will see a tax increase.
It’s not clear, however, whether that applies only to ordinary income or investment income as well. The administration has yet to issue a formal proposal. If investment income below $400,000 is not exempted, it’s hard to see how it wouldn’t have an effect on a broader swath of investors—or retirees who rely on dividends for a substantial portion of their income.
Phil Orlando, chief market strategist at Federated Hermes, believes markets saw a glimpse of what could happen last September and October when it became apparent that Biden was likely to be elected. In those two months, the S&P 500 dropped 10%. But the S&P tech index, which had completely outperformed every other benchmark in 2020, fell 20%.