President Biden’s “once in a generation” plans to raise dividends and capital gains tax (CGT) to a record 39.6 percent have had a polarising effect on the financial sector, with some arguing that it would severely threaten economic stability.
“Despite the administration playing it down, the impact is enormous – we are in very serious trouble,” says Robert Zuccaro, chief investment officer at investment advisory firm Target QR Strategies.
Zuccaro argues that securities and derivatives markets will take a major hit from the proposals. He says that a reluctance to invest will result in lower federal income.
“The impact is enormous. Historically, when capital gains rates have gone up, collections have gone down. Capital will be locked up and prevented from moving to more efficient areas of the economy.”
With a pre-existing surtax of 3.8 percent for Medicare, the fresh increases could bring the top rate to a total of 43.4 percent.
US equities tumbled on rumours of the proposed CGT hike on April 22. All 11 sectors of the S&P 500 traded lower, and some technology stocks were hit.
“The whole thing is an exercise in futility – it makes no sense,” says Zuccaro. “We are crowding out the private sector, which produces goods and services and is solely responsible for elevating the standard of living.”
Zuccaro also laments what he describes as a “spending binge” by the US government. This, he argues, could bankrupt the country and spark a depression.
According to Statista, the US national debt stands at more than $28trn as of April 2021 – nearly double what it was a decade ago.
“There’s a point at which increasing tax rates actually leads to lower government revenue,” says Brian Smedley, head of macroeconomic research at global hedge fund Guggenheim Partners.
Smedley points to the Laffer Curve – an economic principle theorising that as tax rate increases, revenue only increases up to a certain point. Beyond this point, higher taxation can produce a negative effect on federal revenue.
“Over time, the increase would have an effect of dampening investment in the economy, which would curtail growth,” says Smedley.
“In the near-term it’s a story of uncertainty, and a certain degree of risk for people who are going to be subject to these increases. There are enormous redistributional consequences.”
Ryan Bray, partner at law firm Shearman & Sterling argues that some short-term pain may be on the horizon.
“One thing you’re going to see is a rush of people trying to sell their businesses at the end of 2021 – so I think you will see transaction volumes significantly increasing soon.”
“And if people can’t sell their stock by the end of the year, they’re going to find ways to recognise gain in 2021.”
Bray expects to see investors trying to structure into different entities due to the Qualified Small Business Stock (QSBS) exclusion. QSBS capital gains are exempt from federal taxes.
However, he also acknowledges some of the potential flaws in the proposals. Most notably, relatively low earners could be hit by these tax hikes due to high-value assets such as real estate.
“I think that’s something that may be hard to justify politically. That’s not the person the law was trying to get at.”