President Biden's push to nearly double the tax rate paid by wealthy investors when they sell stocks and other assets could actually cause federal revenue to drastically decline over the next decade, according to a new analysis published Friday.
Findings from the Penn Wharton Budget Model, a nonpartisan group at the University of Pennsylvania's Wharton School, show that Biden's proposal to raise the capital gains tax rate to 39.6% from 20% for Americans earning more than $1 million could reduce federal revenue by $33 billion between 2022 and 2031.
The president is expected to include the tax hike in his forthcoming spending proposal, dubbed the American Families Plan. A source familiar with the matter told FOX Business that Biden intends to keep an existing surcharge in place, bringing federal tax rates for the wealthy as high as 43.4%.
But unless Biden couples the increase with a plan to eliminate the so-called stepped-up basis, it won't be the revenue-raiser that his administration wants it to be, according to Penn Wharton.
"Avenues for legal tax avoidance limit the revenue-raising potential of capital gains taxation," the analysis said. "Reforms such as eliminating stepped-up basis and mark-to-market taxation would restrict those avoidance opportunities, therefore increasing revenue raised per percentage point of capital gains tax."
That's because under current law, when heirs inherit an asset that has appreciated in value, they get a "step-up" in basis, meaning they receive the holding at its current market value. Beneficiaries can sell those assets and pay capital gains based only on the time they receive the asset and the time they sold it, allowing them to minimize the tax bite. The Penn Wharton analysts cited evidence that demonstrated when taxes on capital gains rise, realizations of those same capital gains fall – and vice versa.
"Because taxes are due upon realization rather than accrual, taxpayers can use several strategies to time realizations in way that reduces liability," the authors wrote.
If Biden closes that loophole as part of his tax and spending plan, however, raising the capital gains rate could generate $113 billion over the same time period.
Taxes on long-term capital gains – generally classified as an asset that's held for more than one year – currently range from 0% to 20%, depending on a person's income. Wealthier investors are also subject to an additional 3.8% tax on long- and short-term capital gains that's used to fund ObamaCare. Short-term capital gains on assets sold within a year are typically taxed as ordinary income.
Capital gains are taxed favorably when compared to wage and salary income; under existing law, the richest Americans pay a top tax rate of 37% on ordinary income, while the top tax rate on capital gains is 23.8%.
But Biden is seeking to reverse a long-standing provision of the tax code that imposes substantially lower rates on successful investments than ordinary income.
The president campaigned on equalizing the capital gains and income tax rates for rich Americans.