The 2024 Election: A Battle for Your Capital Gains
As the 2024 election heats up, investors are closely watching the candidates’ proposals on capital gains taxes. Both parties have put forth plans that could significantly impact how much taxes investors pay on profits from investments. Vice President Kamala Harris, the Democratic nominee, proposed a 28% tax on long-term capital gains for those earning over $1 million annually, a significant increase from the current 20%. Meanwhile, former President Donald Trump has been vague about his plans but has broadly supported tax cuts. The potential ramifications of these proposals are significant and could influence investment strategies and market behavior in the coming years.
Key Takeaways:
- Democratic proposals aim to increase capital gains taxes for higher earners, potentially boosting revenue and addressing income inequality.
- Republican proposals lean toward tax cuts, potentially incentivizing investment and economic growth.
- The outcome of the election and subsequent congressional control will determine which direction capital gains tax policy takes.
Democratic Plans: Aiming for Increased Revenue and Fairness
Vice President Harris’ proposal is a bold move aimed at raising revenue from the wealthiest Americans. Her plan aligns with the Biden administration’s 2025 budget, which proposes a 39.6% long-term capital gains tax rate for those earning above $1 million annually. The proposed 5% increase to the net investment income tax (NIIT), from 3.8% to 5%, would add to the total capital gains tax burden for those exceeding a certain income threshold.
Senator Bernie Sanders, a vocal advocate for progressive policies, has voiced support for Harris’ proposal while advocating for even higher rates. He believes that "she’s trying to be pragmatic and doing what she thinks is right in order to win the election."
However, the potential impact of these proposals is not limited to the immediate tax burden. These policies could "lock in" investors, discouraging sales and potentially hindering economic growth. The argument for higher capital gains taxes, however, centres around achieving fairness in the tax system and ensuring that wealthy individuals contribute a larger share to public services.
Republican Plans: Tax Cuts and Economic Growth?
Former President Trump’s position on capital gains taxes is less defined. While he has expressed general support for tax cuts, he has not yet offered a specific proposal for capital gains. The Project 2025, a plan developed by conservative think tank The Heritage Foundation, proposes a 15% tax rate on capital gains and dividends and an elimination of the NIIT. However, Trump has distanced himself from this plan.
Proponents of tax cuts argue that they incentivize investment and economic growth. Lowering capital gains taxes, they argue, encourages entrepreneurs and investors to take risks, leading to increased economic activity and job creation. However, critics argue that tax cuts disproportionately benefit the wealthy, widening the gap in income inequality and potentially straining government resources.
A Look Back: The History of Capital Gains Tax Rates
Understanding current proposals requires looking back at the historical evolution of capital gains tax rates. In recent decades, they have generally been lower than "ordinary income" tax rates. This difference can be traced back to the idea that taxing capital gains at the same rate as regular income can discourage investment.
Garrett Watson, Senior Policy Analyst and Modeling Manager at the Tax Foundation, notes that "We’ve applied preferential rates to qualified dividends and long-term capital gains, and that rate has trended downward over time." Harris’ 28% top capital gains rate would mirror the rate enacted by former President Ronald Reagan in 1986.
However, the Tax Policy Center points out that the 15% rate applied during the Bush administration, from 2003 through 2012, was the lowest since the Great Depression. This period was marked by a surge in economic activity, bolstering the argument for lower capital gains taxes. Nevertheless, the volatility of capital gains revenue, influenced by investor behavior, makes it challenging to assess the long-term impact of rate changes.
The "Lock-In Effect": A Complex Economic Implication
The potential "lock-in effect" is a significant concern. This concept suggests that higher capital gains taxes can discourage investors from selling assets, even if those assets are performing well. This can lead to a less dynamic market, as investors are less likely to re-allocate capital.
Kent Smetters, a Professor of Business Economics and Public Policy at the University of Pennsylvania’s Wharton School, acknowledges the "lock-in effect" and its potential to intensify with higher tax rates. This is a critical consideration for policymakers, as it could negatively impact economic growth and efficiency.
The Future of Capital Gains Taxes
The 2024 election will likely determine the future of capital gains taxes for the near future. Both candidates’ positions present a stark contrast in philosophies, with significant implications for investment strategies and overall market behavior.
Whether the Democrats succeed in raising taxes on the wealthy or Republicans push for further tax cuts, the debate will continue. The ultimate impact on investors and the overall economy will depend not only on the policies themselves but also on how effectively they are implemented and what other economic conditions prevail.
The 2024 election might not provide all the answers, but it will surely shape the direction of capital gains tax policy for years to come.
