With the upcoming election, investors are closely monitoring the proposed capital gains tax changes and how they could potentially affect their investments. Recently, Democratic presidential nominee Vice President Kamala Harris suggested a 28% tax on long-term capital gains for individuals earning more than $1 million annually. This proposal represents an increase from the current 20% rate. Senator Bernie Sanders expressed a desire for an even higher tax rate, indicating a divide within the Democratic party on this issue.
On the other hand, President Joe Biden’s 2025 budget includes a plan for a 39.6% tax on long-term capital gains for those making over $1 million per year. Additionally, Harris’ proposal would raise the net investment income tax (NIIT) from 3.8% to 5%. In comparison, Biden’s plan also includes an increase in the NIIT for individuals with a modified adjusted gross income (MAGI) above $400,000. This potential raise in the NIIT could result in a combined rate of 33% for top earners under Harris’ plan and 44.6% under Biden’s proposal.
Alternative Approaches
Former President Donald Trump, known for his support of tax cuts, has not outlined a specific capital gains tax proposal. However, Project 2025, a conservative vision supported by The Heritage Foundation and other right-leaning organizations, advocates for a 15% tax rate on capital gains and dividends, along with the abolishment of the NIIT. While some Trump officials have connections to this plan, the former president has distanced himself from it.
It is essential to note that any changes to capital gains tax rates, whether an increase or decrease, would require Congressional approval. The uncertainty surrounding the control of the House and Senate further complicates the potential implementation of these proposals.
Over the years, capital gains tax rates have generally been lower than ordinary income tax rates. If Harris’ proposed 33% combined capital gains rate were to be implemented, it would mark the highest rate since the late 1970s. Comparatively, her suggested 28% top capital gains rate resembles the rate set by former President Ronald Reagan in 1986.
In recent history, capital gains tax rates have fluctuated significantly. Following tax cuts introduced by former President George W. Bush, the top capital gains tax rate dropped to 15% between 2003 and 2012, the lowest level since the Great Depression. However, the volatility associated with capital gains revenue, influenced by investors’ selling behaviors, adds complexity to revenue estimation and tax policy planning.
The preferential treatment of capital gains, along with the flexibility investors have in choosing when to realize gains, can impact their decision-making. Higher tax rates may lead investors to defer selling assets, while lower rates could prompt strategic realization of gains in favorable tax brackets. The lock-in effect associated with capital gains, where investors hold onto assets to avoid higher taxes, becomes more pronounced with increased tax rates.
The proposed changes in capital gains tax rates could have significant implications for investors, influencing their investment strategies and decisions. The diverging proposals from different political parties reflect the ongoing debates on tax policy and its broader economic ramifications. As investors navigate these uncertain times, understanding the potential impacts of these tax changes is crucial for informed decision-making.