President Biden has just announced his proposal for increasing long-term capital gains tax rates (as part of his American Families Plan). The long-term capital gains rate applies to realized gains on stocks held for at least one year, and is currently lower than the tax rate for ordinary income (or wages). For instance, the top long-term capital gains rate (for married couples making more than $496,600 per year) is 20%. The top ordinary tax rate is 37%.
Biden is widely expected to eliminate this difference, taxing long-term capital gains at the same rate as ordinary income. Under the plan, both the long-term capital gains rate and the top ordinary tax rate would increase to 39.6%. However, his proposal comes with one big caveat: The change will only apply to households making more than $1 million per year.
So why should anyone care who earns less than that?
The top 1% of households in the U.S. control nearly 40% of the value of the stock market, according to the NY Times. A higher capital gains rate proposed for next year could induce selling this year, as wealthy households race to take advantage of the preferential rate. After strong stock market gains in 2019, 2020 and so far this year, wealthy investors are likely sitting on a mountain of gains. This could create a rare buying opportunity for everyone else.
For those making more than $1 million per year, the decision to sell now will be based on many factors, including how much the stock is appreciated, the desire to hold the stock longer-term, and expectations for income going forward. While these decisions will be made as details of the proposal are released, it’s clear that the successful passage of a higher capital gains tax rate for next year is likely to usher in some level of selling pressure this year.
History tells us it will be temporary. While wealthy investors may sell stocks now to take advantage of lower tax rates, they will likely be buyers again in short order. With bond yields at all-time lows, the stock market remains the only game in town to build wealth over time. A higher capital gains tax rate won’t change that.