Voters who understand economics must wonder about President Joe Biden’s mental capacity when he proposes tax policies that would undermine the nation’s future prosperity. Biden appears to want an economically weak nation where young people would experience a steadily declining standard of living.
I say this because in his 2025 budget request, Biden proposes to raise the tax rate on long-term capital gains — assets held for a year or longer — to the same level as the tax rates on ordinary income. Biden’s proposal would raise the top marginal rate on ordinary earned income from the current 37% to 39.6%, and he proposes taxing long-term capital gains income for the more successful at ordinary income rates.
Under current law, for the most affluent, long-term capital gains are taxed at 20%. Short-term capital gains are already taxed at ordinary income rates. For high earners, those with incomes above $250,000, there is already an additional tax on long-term capital gains, the so-called net investment tax which was introduced during the Obama administration to fund in part Obamacare. That additional tax is currently 3.8%. Biden wants to jump that tax up to 5%.
Put simply, capital gains which are currently taxed at 23.8% for high earners would jump to 44.6%. That is terrible tax policy.
Investment drives productivity growth, and productivity growth is what raises the standard of living for every person. Increasing the capital gains tax by almost 100% will reduce investment, lower productivity growth, and over time make every person less well-off. Biden would reduce the post-tax return on investment. At the margin, would-be investors would thus spend their money on something else besides investment. Investors would spend more on consumption and not defer gratification through investment. Spending more on consumption would compound the existing problem of a very low personal savings rate, which is one reason why the U.S. imports capital and runs a current account deficit.Â
The U.S. economy is not self-sustaining, unlike the Chinese economy. China does destroy capital through wasteful investment but at least China controls its economic fortunes. Because of its very low personal savings rate, the U.S. is beholden to foreign investors to fund the deficit and to make crucial investments in infrastructure and intellectual property. It is a terrible situation when the U.S. is forced to rely on China for capital.
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In a perfect world, then, the U.S. would actually lower the rate on capital gains, not raise the rate. Lower capital gains tax rates increase the post-tax return on investment and encourage more investment. Greater investment leads to higher productivity growth and greater prosperity for all. If the tax rate on capital gains were lower, the U.S. trade deficit would probably be lower. Monies that were spent on consumption would be spent on investment. High earners save more than households with lower disposable income. High earners respond to higher returns. If savings were higher, it would be easier to fund the federal deficit. Interest rates would be lower. Lower interest rates drive more investment. A positive feedback loop is created when domestic savings increase. Investment is higher, productivity increases faster, and the overall standard of living improves at a more rapid rate.
From the standpoint of economic growth, the most efficient capital gains tax rate would be zero. A zero capital gains tax rate would reduce economic friction on investment to a de minimis level.
Biden’s proposal to double the capital gains tax rate is idiotic.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note.
