The proposals to amend the tax law are causing a stir. Not that such changes are new. On average, Congress has changed tax laws every 18 months since 1945. Although the new tax ideas may affect us all, we need to keep perspective.
President Joe Biden proposes a $ 1 trillion increase in investment taxes by increasing capital gains tax to 39.6% for those earning $ 1 million or more. The estimate is for tax revenue to grow by $ 1 trillion over the next decade. Those in the highest tax bracket could see their federal rates go up to 43.4%.
Will the rich sell investments and generate nearly double the capital gains tax they currently pay?
Realistically, these estimates may be overly optimistic. All taxpayers at any level can potentially avoid most of the tax, according to a new analysis of the University of Pennsylvania's Penn Wharton budget model.
A large number of empirical studies have shown that investors are less likely to make capital gains when taxes on them rise. Compared to other forms of income that are taxed under individual income tax, capital gains react relatively quickly or flexibly to tax rates.
In other words, an increase in capital gains tax will cause wealthy Americans to avoid selling treasured stocks and other assets, combine profits with losses for tax harvest, and slowly sell investments to minimize taxes, say the Wharton researchers. Taxpayers will minimize capital gains taxes as much as possible because they can control the timing.
Another proposed directive eliminates the increase in the base for assets when an investor dies. This policy enables taxpayers to pass on highly valued assets to heirs tax-free. This will have more of an impact on people in states where housing costs are as high as California. If the hike were lifted, the proposed tax rate hike over 10 years would raise $ 113 billion, just a fraction of the estimated $ 1 trillion. Conversely, taxpayers would have an incentive to postpone investment sales indefinitely if the topping up of the base remains unchanged.
Another interesting idea is that taxpayers could instead give away high-profit investments to nonprofits, avoiding the profits and creating instant deductions that would protect other profits. These are tools that can and will be used regardless of changes in tax law.
Will Congress be able to pass both policy changes? Usually each special interest group influences the details as the legislation passes through Congress. Either the capital gains tax or the abolition of the reinforced base could be eliminated or even partially eliminated.
The Wharton study made a critical remark that the amount of revenue the government collects will remain the same.
“Despite the large fluctuations in tax rates over time, the percentage of GDP accumulated from taxes is remarkably constant. When prices go down, people worry and are less likely to avoid it. As the rates get higher, they jump through more hoops to avoid this. One thing is for sure, the proposed tax increases in Biden won't generate as much revenue as they predict, but you can be sure that the cost will be spent. "
Don't let the sensational headlines torment you. Take a close look at the substance. Realize that you have many tools available to help you manage your tax situation.
Mark Sievers, President of Epsilon Financial Group, is a certified financial planner with a Masters degree in Business Administration from the University of California at Berkeley. Contact him by email at (Email protected).