Will raising the US capital gains tax help tackle inequality?

The near-doubling of the capital gains tax on wealthy Americans is a centrepiece of United States President Joe Biden’s $1.8 trillion American Families Plan.

In his address to Congress on Wednesday evening 100 days into his term, Biden described the proposal as “fiscally responsible” and added that the wealthiest Americans will “pay their fair share”.

The difference between taxes on income, which is how most Americans make their money, and capital gains — how many wealthy people grow their personal fortunes — has long been lambasted by critics as a driver of inequality.

But will raising the capital gains tax narrow the divide between the nation’s haves and have-nots?

First things first. What exactly is a ‘capital gain’?

It’s basically the profit someone makes on an investment after selling it. Think stocks, bonds, precious metals, jewellery and cryptocurrencies as well as houses and other real estate.

So what’s a capital gains tax?

It’s the amount of money investors must pay to the government on the profit they make when they sell an asset. The profit is determined by how much it cost them to buy and how much they sold it for.

So how does the current tax system worsen inequality?

At present, wealthier Americans make a disproportionate share of their income from profits made by cashing in equities and other investments. For assets owned for a year or more, the capital gains tax can range from 0 percent to a top base rate of 20 percent, depending on filing status and other taxable income.

Meanwhile, income tax rates range from 10 percent to a top rate of 37 percent.

You mentioned how long someone owns an asset. Does that matter?

Yes. Because short-term capital gains — profits on assets held for less than one year — are generally taxed as ordinary income. Day traders, beware.

So, what exactly is Biden proposing?

At the federal level, Biden wants to raise the long-term capital gains tax rate for households that make more than $1m in income annually to 39.6 percent – nearly double the current top base rate.

I’ve heard the number 43 percent floating around, though. Why?

That’s because there’s a 3.8 percent net investment income tax that funds Obamacare health insurance for Americans. So in practice, Biden’s proposed capital gains tax hike would take the combined federal top rate to 43.4 percent.

How much money would that generate for the federal government?

According to the Penn Wharton Budget Model, Biden’s proposed capital gains tax hike could actually decrease revenues by $33bn over the next ten years. That’s because people can use all sorts of strategies to lower their capital gains tax bills. Like investing in tax-sheltered investments, putting off the sale of assets until a more investor-friendly tax regime is in place, or only cashing in some investments in years that money has been lost on others.

What if other changes were made?

If Biden’s capital gains tax hike was also accompanied by another change he’s seeking on how capital gains on assets people inherit are taxed, then Penn Wharton reckons the proposed changes could actually raise $113bn in revenue over the next decade.

How many Americans would be hit by just an increase in the capital gains tax?

According to Biden’s speech on Wednesday: “We’re only going to affect three-tenths of one percent of all Americans by that action. Three-tenths of one percent.”

So what does Biden want to do with the money the tax change would raise?

His American Families Plan plan includes $1 trillion in new benefits spending over 10 years on childcare, education and paid leave, plus $800bn in extended tax credits.

Are there any downsides to raising capital gains?

Some economists argue that hiking the capital gains tax would deal a blow to entrepreneurial finance because it would penalise investors. As soon as Wall Street caught wind of Biden’s proposed capital gains tax hike, stock prices took a hit.

Is there a counter-argument to that?

Biden counters that his economic proposals will “reward work, not just wealth”.

What else is Biden proposing to do to get the rich to pay more taxes?

Biden wants to beef up Internal Revenue Service enforcement efforts – reportedly to the tune of $80bn- to give the agency more firepower to crack down on wealthy tax cheats.

He also wants to restore the marginal tax rate paid by households earning more than $400,000 annually back up to 39.6 percent.

Will that be enough to pay for his $1.8 trillion American Families Plan?

According to the White House, Biden’s proposed tax increases will raise $1.5 trillion over the next decade – enough to fund the majority of the plan. But taxes are a slippery business. The wealthy are very good and finding ways to avoid paying their fair share, so take any projections – especially rosy ones – with a boulder-sized grain of salt.

What other tax changes is Biden seeking?

Biden wants to hike the corporate tax rate to fund the lion’s share of his proposed $2.25 trillion American Jobs Plan to upgrade the nation’s infrastructure.

Where does the tax proposal go from here?

The Biden administration is set to provide Congress with more details in May about spending and taxation provisions in its formal budget. The American Families Plan could be included in a reconciliation bill that does not require bipartisan support in either the House or Senate. However, moderate Democrats will face pressure from Republicans as the relevant congressional committees draft the new legislation. Analysts say the final bill may not reach the Oval Office until late summer or early fall.