Capital Gains Tax Can Exceed 100 Percent Under Biden Proposal: Economist

President Joe Biden briefly addresses journalists moments before departing from the South Lawn of the White House on Mar. 3, 2023. Roberto Schmidt/AFP via Getty Images

President Joe Biden’s proposed capital gains tax increase could result in an effective tax rate of more than 100 percent after adjusting for inflation, according to estimates by economist Arthur Laffer, a former adviser to Ronald Reagan. The increase would more than double the tax investors pay on investments held longer than one year.

The proposal, outlined as part of Biden’s $6.8 trillion budget plan for 2024, would increase the capital gains tax rate for individuals earning more than $1 million per year to 39.6 percent from the current rate of 20 percent. It would also increase the Affordable Care Act surcharge to 5 percent, bringing the total tax rate for high-income investors to 44.6 percent.

This would mean that investors could face an effective tax rate of 86 percent on after-inflation profits from holding an investment, assuming inflation returns to the Fed’s 2 percent goal, according to economist Stephen Moore, author of the Committee to Unleash Prosperity newsletters.

If the inflation rate remains at current levels, the real capital gains tax could reach above 110 percent, Moore said in a note, referring to a chart prepared by Laffer.

Source: Center to Unleash Prosperity/Laffer Associates

“What’s the right and fair tax to levy on investments?” Moore asked. “Should the government take it all and then some?

“If you buy a stock for $100 a share and then it rises to $120 per share five years later, but the accumulated inflation rate over that period was, say, 24 percent, then you lost money owning the stock after adjusting for inflation. You would still owe Uncle Sam a 40 percent tax on the phantom ‘gain’ of $20 per share. This is sheer idiocy.”

Since the nominal rate of return on some assets is lower than the rate of inflation, Biden’s capital gains tax “can reach infinity,” according to Laffer’s estimate.

Biden’s plan would also eliminate a tax provision known as “step-up in basis,” which allows heirs to avoid paying capital gains taxes on assets that have appreciated during the previous owner’s life.

Some market participants argue that eliminating this law may prove problematic.

“There could be great difficulty in estimating what the original cost was,” macro analyst Peter Grandich said. “Taxing the party passed onto could cause serious issues with illiquid assets inherited.”

He also said excessive capital gains taxes will discourage investment by reducing returns, which are “the incentive to invest long-term.”

The Biden administration has defended the proposal as a way to fund critical investments in education, child care, and other social programs. However, it remains to be seen whether the proposal will gain enough support in Congress to become law.