U.S. Markets closed

Biden’s Tax Plan Is Better Than It Looks

Karl W. Smith

(Bloomberg Opinion) -- One of the objectives of Joe Biden’s tax plan, clearly, is to increase the amount of taxes wealthy Americans pay without imposing a new tax on Americans’ wealth. By this standard — and a few others for which economic conservatives can be grateful — it succeeds.

Biden’s plan is far from ideal. But in today’s political climate, and compared to some proposals offered by his rivals for the Democratic presidential nomination, it is realistic and makes an honest effort to limit any negative impact on economic growth.

A lot of attention has focused on the plan’s increase of the corporate tax rate to 28% from 21%. But the changes to the individual tax code are also important, in particular its treatment of capital gains: It would increase the maximum long-term tax rate on capital gains from 23.8% to 43.4%, and it would end the favored tax treatment of capital gains when they are passed on as an inheritance.

That is an eye-popping increase in the capital gains tax. And while there is close to a consensus among tax experts that large increases in the capital gains tax can be self-defeating, Biden’s plan tries to mitigate them.

There are at least three reasons even liberal economists are wary of higher capital gains taxes. Biden’s plan addresses one of these concerns directly, and another is rendered less disconcerting by the changing global economy.

First, the revenue raised by capital gains taxes is highly sensitive to the tax rate, because investors tend to delay the sale of assets in order to defer tax payments. In particular, older investors can choose never to sell their investments at all and simply pass them on to their heirs. When they die, all the tax liability they incurred over their lives is erased.

For example: Grandma bought Apple stock for $2 two decades ago. When she died last month, she gave all her shares, now worth $260 each, to her grandson. If he sells them next week for $265, he pays taxes only on that $5 profit — not on the $263 rise in value since his family bought the stock.

Under Biden’s plan, however, he would have to pay taxes on $263. This provision would make it much harder for investors to avoid the capital gains tax.

There is another reason capital gains taxes are traditionally lower than those on ordinary income. High tax rates on individual investors discourage savings generally. Savings help fund business investment, which in turn drives productivity growth and higher wages. So encouraging greater savings has long been seen as way to increase wages and incomes overall.

The current U.S. economy, however, attracts savings from all around the world. The key determinant of U.S. investment is not necessarily the tax treatment of domestic investments, but how favorable returns on capital are in the U.S. relative to the rest of the world. Taxing American investors at higher rates doesn’t necessarily put U.S. capital at a disadvantage.

Unfortunately, Biden’s plan does little to address a third argument against higher capital gains taxes. A large portion of the tax falls on investors in public corporations. Corporations already pay a 21% tax rate. When combined with the 23.8% tax rate on capital gains, the effective tax rate is 39.8%, just the above the plan’s proposed maximum rate of 39.6% on individual income.

Raising the capital gains tax rate to 43.8%, along with Biden’s proposed corporate tax rate increase to 28%, would create an effective top tax rate of 59.2% on publicly traded companies. That’s extraordinarily high, and would undoubtedly both reduce the amount Americans invest in the stock market and encourage public companies to go private. Such tax-avoidance schemes would decrease efficiency, and the Biden plan does little to compensate for that.

Overall, Biden’s proposal would hit investors hard, and the increase in the corporate tax rate would reduce GDP in the long run. But it needs to be considered in context of the Democratic campaign.

Compared to the wealth tax proposed by Elizabeth Warren and Bernie Sanders, the mark-to-market capital gains tax proposed by Cory Booker, or the full repeal of the corporate tax cut advocated by Pete Buttigieg, it’s a moderate proposal. (Michael Bloomberg, the founder of Bloomberg LP and a Democratic presidential candidate, has yet to release a detailed tax plan.) Economic conservatives should take Biden’s plan seriously.

To contact the author of this story: Karl W. Smith at ksmith602@bloomberg.net

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior.

For more articles like this, please visit us at bloomberg.com/opinion

©2019 Bloomberg L.P.