It’s exciting when you buy a stock which goes up. Some of that excitement dies down when you sell the stock and realize that you didn’t hold it for at least 1 year and therefore are paying a 40%+ tax rate on your gain, especially if you live in a place like New York or California. The Capital Gains tax has been a volatile and debated tax going back nearly 100 years. Because the majority of capital gains taxes collected are on assets held more than one year, the long-term capital gains rate is at the center of this tax debate. Up through 2012 we had a somewhat friendly rate of 15% due on long-term capital gains. However, that amount jumped to 20% recently and is even higher (23.8%) if you earn a decent living and are subject to the Affordable Care Act surcharge. Capital gains taxes are collected at the state level as well, adding another layer of pain if you live in a state which imposes this tax. At the heart of the capital gains debate is the question: do capital gains taxes harm economic growth and reduce the rate of savings and investment?
There’s no doubt that low or no capital gains rate would encourage more people to place market investments, especially the younger generation which is somewhat skeptical to begin with, having watched the market collapse of 2008-2009, likely a time when they were new to the investing world. However, as a major source of tax revenue, would eliminating capital gains taxes surely create enough economic growth to recreate that missing revenue in the form of other taxes? That is a tough question, especially because economic growth is the result of many different factors coming together.
Data demonstrating exactly how correlated capital gains taxes are to economic growth are hazy at best. Throughout history, economic growth has often been strong at times when the capital gains rates were high, but people will point out that often those capital gains rate hikes were during and following periods of sustained economic growth.
Notable investors including Warren Buffet have commented that capital gains taxes aren’t enough of an issue to prevent people from taking advantage of investment opportunities. The capital gains tax, while annoying at 20% or even more annoying at 25% shouldn’t logically prevent someone from buying an asset with appreciation potential. If those dollars were to earn 0 sitting in cash, it is logical to assume a person is likely to place the same investment, even if the government takes a share of the profits. So really the issue comes back to whether a reduction or elimination of the tax would spur the economy enough to more than offset the value of that tax to the government.
Frankly, while the answer to that question may be yes, I don’t think we’re going to find out anytime soon. The federal budget is stretched thin as it is and we’re likely in a long period of tax rate increases, not decreases.
As always, feel free to reach me with any questions or concern.
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This discussion is for informational purposes only and is not intended to be specific advice. The economic forecasts set forth in this commentary may not develop as predicted.