The Problems With RetroactivityĪside from these undesirable economic effects, supporters of the policy face another challenge: retroactivity is not a legal slam dunk. If a tax increase is structured so that the effective date already happened months ago, investors would obviously have no chance to unload assets at favorable tax rates before the new policy kicks in. The reverse is also true, with capital gains collections soaring in the years following a rate reduction.Įxperts differ on why, but the general theory is that hiking the capital gains tax pushes people to shift from long-term investment activity toward short-term consumption activity, cashing out and spending the money since the tax rate on investing the money is the same or higher. One reason President Biden and key Democrats may want a capital gains tax increase to be retroactive is because there are numerous studies demonstrating that whenever a capital gains tax increase is about to take effect, there is a rush of sales (“realizations”) and a one-time spike in capital gains tax collections, followed by multiple years of lower levels of collections. Unprepared small businesses and taxpayers facing this historic economic hit retroactively will be especially hurt, particularly coming after a COVID pandemic that has devastated many of them. The Penn-Wharton tax model generally produces results that are similar to those of the Congressional Budget Office, which suggests that Congress’s official scorekeeper is unlikely to see a capital gains tax hike producing large amounts of revenue. Analysts at Penn-Wharton concluded that Biden’s proposed capital gains tax increase would lower federal revenue by $33 billion, rather than raise the administration’s estimate of $370 billion or more. Moreover, such a tax hike wouldn’t even accomplish the desired goal of increasing revenue. The combined average federal and state capital gains would surpass Denmark, Chile, and France to become the highest capital gains tax rate in the industrialized world. Under this proposed tax, combined federal and state taxes on capital gains would average 48 percent (itself a 66 percent increase over current law), exceed 50 percent in thirteen states and the District of Columbia, and reach 58.2 percent in New York City. A recent Wall Street Journal article already shared one story: Paul Settle, a 64-year-old Kentucky man who has fixed up five apartment buildings and plans to retire on the proceeds, would see his savings cut in half by the proposal, even though he makes only $75,000 per year. P resident Biden’s proposed retroactive capital gains tax increase will produce real harms. Biden’s capital gains proposal may serve as the starting point of the discussion for Congress. This would be in addition to Biden’s “stepped-up basis” proposal to impose capital gains at death above a $1 million exemption, which would also be in addition to the existing estate tax. President Biden’s budget proposal suggested raising the rate on such capital gains to 43.4 percent for households with income over $1 million, effective for all sales on or after April 2021. One idea in play is a retroactive capital gains tax increase, raising the top tax rate, currently 23.8 percent, imposed on the gain from the sale of assets held longer than a year. As part of that package, the Democratic majority is considering a number of tax increase ideas: raising the top rate to 39.6 percent, increasing the corporate tax from 21 percent to 28 percent, a minimum “book” profits tax, taxing investment income as ordinary income, levying a 10 percent surtax on high earners, imposing a one-time 2.5 percent wealth tax, and imposing an annual 2 percent or 3 percent wealth tax. Having resolved the infrastructure bill, Congress now begins debate and consideration of the budget through a reconciliation process since that can be passed with 50 votes, bypassing the normal process that subjects legislation to filibusters.
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