We Ask Tom How Increased Corporate and Capital Gains Taxes Might Affect Investments
Transcript:
Easan Arulanantham:
So, how does Biden’s plans with increasing taxes, corporate taxes or capital gains affect my portfolio in the long run?
Tom Vaughan:
Well, that’s a big issue right now, because, you know, we’ve got this these massive programs that are being suggested the American jobs plan, which is roughly $2.3 trillion Americans family plan which was just announced this week, which is $1.8 trillion, and they’re trying to find some ways to fund those outflows. And so, you know, a couple of things are coming up.
Number one is corporate taxes. So corporate tax rates, the high rate was 35% 2017, that was moved down to 21%. They’re now looking to move that back up to 28%, to try to fund some of this infrastructure spending, for example. And they’re also looking at the possibility of moving up capital gains rates from the top bracket would be 20%. Now to 30, possible top bracket a 39.6%. And that’s only for people that have over a million dollars.
So let me talk about those individually. First of all, one thing to keep in mind that as far as I can tell, right now, from what we’ve reading, what they’re asking for, in terms of, let’s say, for example, the corporate rate at 28%. I don’t think they’re gonna get it, I think it’ll probably be 25%. So, you know, we’re not there yet. It’s not done. We don’t know what the actual numbers are. But if it is at 28%, the projections are that you would see about a five to 9% decrease in the earnings for the S&P 500, for example, that’s what I’ve read. And so that would have an impact.
I mean, earnings are the ultimate driver long term of the stock market. And so it would certainly at least have a short term impact. Having said that, the rates used to be at 35%. And we had some phenomenal stock market rallies when the rates were that high. So if you look at it, the corporate tax rate is important. And I think it would be an important short term issue. But it’s going to be one of those things, I think, once it kind of works its way through. The other thing that’s very important about this, at least in the short term is that it is attached to a spending bill. So maybe the corporations as a whole get less earnings.
But then there’s more government spending coming out, which could increase the economic economy in total, and maybe increased revenues, at least somewhat. So to offset some of that loss in earnings. The capital gains tax is a little bit different, you know, the habitat stated issue of saying, Hey, we don’t want to increase taxation on anybody below $400,000 worth of income. But if they make a $1 million capital gains tax increase that nearly doubles capital gains at that point in time, it sounds like, hey, a million dollars. Well, I have a lot of clients that have more equity in their home than that right now. And they don’t make $400,000. So if they went and sold their home, we would end up with a situation where somebody making less than $4,000 is going to end up with, you know, a potentially higher tax bracket. As far as that goes.
The other fascinating thing about the capital gains I just read, there was a study done by Wharton. And they said that if if if you increase capital gains, and you still allow people to have a step up basis, so what happens is if if you pass away, your spouse gets a stepped up basis and could sell that house, you know, with no taxes. So if I bought a house for 100,000, that’s worth 2 million. And I would sell that house, I would end up with capital gains. But if my spouse passes away, before I sell it, it moves up to say 2 million basis. So it eliminates that tax. And Wharton said that if you don’t get rid of the step up, combined with the higher taxation, that the government will actually lose $33 billion, because people will just hold on to it and not sell it and just wait until somebody passes away. And then then they could sell it. But if they include a elimination of the step up and basis, so you never get a step up. What do you buy, the stock for $10 is now worth 100. And it always stays your basis always stays at $10 then that will make about $133 billion off of this. So in order for the capital gains tax to actually produce excess revenue to the government, according to Warden, they will have to include a eliminating the step up basis. That’s a pretty big issue with my clients in terms of the step up basis. And again, they would be hitting on people that have less than 4000 of income. So that’s a really big controversial area still going to be developed. We’ll have to wait and see.
Having said that, if you look historically, capital gains rate have very low correlation to stock market performance. It might have some correlation in the short term, because everybody be trying to sell their house at one Once, you know if they have more than a million dollars to pay the 20% gain instead of 39.6. You know, those types of things are selling their stocks, it might impact those stocks like let’s say an apple or a Facebook or what have you that you know where it has huge gains, and probably some people out there with more than a million dollars worth of gains, where they might start to sell those, but they also might make it retroactive, which I really disagree with. But in theoretically, they could say, hey, this already started in the beginning of 2021, then you couldn’t sell anything, it wouldn’t make any difference as far as that goes. So very, very fascinating to see, you know, kind of how that plays out as far as that goes. But that’s that’s the idea behind you know that the taxation portion, but really important to consider, although I don’t know that it will have massive impacts for what they’re talking about right now.