PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

Small Business Owners Understand the Ills of Raising the Capital Gains Tax

By at 13 August, 2021, 7:12 am

by Raymond J. Keating –

In my economics career, I have long argued that the capital gains tax is one of the most destructive levies that government can impose. Indeed, it might be the most damaging tax.

Why?

The capital gains tax is a direct tax on the returns on entrepreneurship and private investment. That is, the capital gains tax reduces the potential returns on and incentives for engaging in starting up, building and investing in businesses, which are endeavors fraught with risk and uncertainty. At the same time, entrepreneurship and private investment serve as driving forces behind innovation, and economic, income and employment growth. Therefore, capital gains taxes rank as highly destructive levies.

Nonetheless, an economy that continues to struggle to recover from a pandemic now faces plans for substantial increases in the federal capital gains tax. Specifically, President Biden has called for increasing the capital gains tax from 20 percent plus the 3.8 percent Obama Medicare tax for a total of 23.8 percent to an increased top personal income tax rate of 43.4 percent on gains worth more than $1 million.

In addition, Biden and various Members of Congress (e.g., via the so-called Sensible Taxation and Equity Promotion (STEP) Act) would eliminate the “stepped-up basis” for assets transferred at death. Tax law has long allowed for a “stepped-up basis” for assets transferred at death, so that they were not hit by the capital gains tax and the death tax.

The stepped-up (or step-up) basis means that the capital gains basis for an inherited asset is stepped up to the fair market value at the time of the original owner’s death. Therefore, when an heir eventually sells the asset in the future, the capital gains tax would apply to the gain in value since, or after, the bequeathal. But the STEP Act would mean that a person inheriting an asset would be taxed on the asset’s appreciation before they took ownership or control. It would be a retroactive capital gains tax. And of course, then total assets inherited would be subject to the estate tax, or death tax. (For a fuller analysis of this proposal, read SBE Council’s brief.)

Better than most, small business owners have firsthand knowledge of how detrimental such tax increases can be, and that was made clear in a new survey of small business owners by SBE Council. Consider just a few results as they pertain directly to these plans to raise capital gains taxes.

• 59% of small business owners oppose a near doubling of the capital gains tax from 23.8% to 43.4%.

• 70% oppose beneficiaries having to pay for capital gains that occurred prior to inheriting an asset.

• 63% believe that increasing the capital gains tax and eliminating the stepped-up basis would disproportionately hurt small businesses.

• 78% of small business owners “believe retroactive capital gains taxes on assets passed on to beneficiaries following a business owner’s death will have crippling consequences for small businesses, as well as their employees and the communities they call home.”

• Nearly, or more than half, of respondents believe having to pay retroactive capital gains taxes of 43.4% on the accumulated value of assets would hurt the ability of family members or heirs to:

(1) keep existing employees (47%)

(2) financially support their own families (48%)

(3) support local charitable organizations (49%)

(4) carry on the family business (50%).

(5) make capital investments in their business (51%)

Interestingly, 48% of respondents said it would hurt their ability to pay federal or state taxes.

The list of negative is lengthy among small business owners when it comes to these plans to raise the capital gains tax and eliminate the step-up basis at death. Small business owners understand that these tax increases will mean fewer resources and reduced incentives for investing in the businesses that drive economic, income and employment growth.

President Biden and Congress should step back from such counter-productive tax increases, and instead, start looking at policies that actually would help entrepreneurship and growth, such as reducing the capital gains tax rate and indexing capital gains for inflation.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

 

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