People are starting to focus on Joe Biden's plan to raise the long-term capital gains tax rate to 43.4% from the current 23.8% for taxpayers earning more than $1 million a year.
The Washington Post reprints a Bloomberg column by Jared Dillian warning, "Such a high rate will likely result in a situation where those sitting on substantial gains will choose to hold those assets far longer than otherwise. A 2010 paper from the Congressional Research Service describes behavioral responses to changes in capital gains tax rates as a "lock-in effect," imposing "efficiency losses because investors may be encouraged to hold suboptimal portfolios." This means that investors will hold onto a stock for tax reasons, rather than selling it and buying a better one, which leads to market inefficiencies."
Dillian also warns, "If Biden wins, any new tax legislation probably wouldn't take effect until 2022. Even so, wealthy people might be inclined to harvest any gains they are sitting on before the end of this year, sparking a wave of selling on the chance that Democrats—assuming Democrats retain a majority in the House and gain enough of a majority in the Senate—would impose a capital gains tax hike retroactive to the start of 2021."
And Institutional Investor reports comments by Citadel's Ken Griffin, also warning about the lock-in effect: "When taxes are at 39 percent, you're not going to sell your winners. You're going to stay in those positions longer than you otherwise would have. That means there's less capital flowing from those companies to the next new idea. That's heartbreaking. Part of the reason that the U.S. economy works so damn well is that we move our capital as a nation to the next new idea continuously... It's the mobility of the capital in our system that makes that happen."
There's some confusion over whether the Biden capital gains rate is properly described as 39.6% or 43.4%. The nonpartisan Tax Foundation has some helpful context: "Biden has proposed taxing capital gains at ordinary income tax rates for taxpayers earning more than $1 million annually. He has also proposed increasing the top marginal income tax rate to 39.6 percent. When this is added to the Net Investment Income Tax (3.8 percent) on married filers (which phases in at $250,000 MAGI), the marginal tax rate on capital gains reaches 43.4 percent. Biden's proposed changes would only affect filers in the top long-term capital gains bracket. Under Biden's plan, the top rate on long-term gains would nearly double from 23.8 percent to 43.4 percent."
