Why is President Biden Choosing Harmful Tax Policies?

By SBE Council at 29 March, 2022, 2:37 pm

SMALL BUSINESS INSIDER

If President Biden has his way, the Biden economy promises to be quite grim.

 By Raymond J. Keating –

President Joe Biden is back with tax proposals that make no economic sense, but hold appeal to those who wallow in class-warfare, get-the-rich politics.

While entrepreneurs, businesses, investors and workers struggle with the effects of the pandemic, inflation, supply-chain issues, the uncertainties of Russia’s attack on the Ukraine, and so much more, including the possibility of another recession over the next year, elected officials should have a laser-like focus on pro-growth policymaking.

Unfortunately, President Biden and many in Congress insist on pointing policymaking in the exact wrong direction.

Hiking the Top Personal Rate Hurts Business Owners and Entrepreneurship

The president’s latest budget plan includes calls for increasing the top personal income tax rate from 37 percent to 39.7 percent, and the corporate income tax from 21 percent to 28 percent. These are standard class-warfare schemes that deserve to be rejected out of hand. After all, why would anyone seek to drain resources from the private sector, discourage entrepreneurship and investment, and make the U.S. less competitive on the world stage in terms of attracting business and capital – again, especially at a time like this?

Higher Capital Gains Taxes Hit Entrepreneurship and Investment

President Biden proposes to raise the top rate on capital gains and dividend income on high-income earners from 20 percent to the top personal income tax rate, which would, again, go from 37 percent to 39.6 percent under the president’s plan (the ObamaCare 3.8 percent Medicare tax also must be applied, by the way). In addition, the step up in basis would be removed, so that death (or a gift) would be treated as a realization event for the capital gains tax.

Biden’s New “Wealth Tax”

While this is being called the “Billionaire Minimum Income Tax,” it’s actually a dangerous amalgamation of an income tax and a wealth tax. Specifically, for households worth at least $100 million, Biden seeks to impose a minimum 20 percent tax on the combination of income and unrealized capital gains.

SBE Council previously explained the various and significant problems with this tax, including the following:

First, calling something “income” does not make it income. In this case, saying that an increase in the value of an asset over a certain period of time is capital gains income, subject to the capital gains tax, when, in fact, no action has been taken to realize a gain (i.e., nothing has been sold), is simply the creation of a political fiction.

Why go through this effort of ignoring or changing the meaning of income?

A tax on simply the increase in the value of assets is a direct tax, and according to the U.S. Constitution, a direct tax must be apportioned among the states, that is, it must be the same amount per person in every state. The 16^thAmendment to the Constitution allowed for an income tax on individuals, and it was adopted to circumvent the direct tax requirement. As explained by Neil S. Siegel and Steven J. Williams, writing for the National Constitution Center (“Direct and Indirect Taxes”):

“Income taxes may be imposed only on ‘derived’ income. This ‘realization event’ requirement generally refers to a transaction other than the mere passage of time. Thus the Sixteenth Amendment permits taxation of gains from sales or exchanges of property, but not those resulting merely from increased values. It also permits taxes on rents and interest. Although direct, such taxes need not be apportioned because the Amendment eliminated the apportionment requirement for income taxes.”

Given that there is no realization event, it cannot seriously be argued that “unrealized” gains are “income” in any sense of the word, and that being the case, this proposed levy would be a direct tax not allowed by the Constitution.

Second, even if the Constitution is ignored (it’s happened many times before, after all), there’s the fact that this proposed tax would take a real toll on investment.

The normal capital gains tax is a destructive levy. It reduces the amount of resources and incentives for starting up and growing businesses. And understanding that entrepreneurship and the financing of entrepreneurial ventures are endeavors fraught with risk and uncertainty, while at the same time such activities are essential to economic growth, the problem with the capital gains tax – a direct tax on the returns on entrepreneurship and investment – becomes, or should become, quite clear.

Now, all of these problems would be multiplied many times over with an annual tax on unrealized capital gains. Indeed, it must be kept in mind that it is high-income earners who have the resources to make investments in starting up and building businesses.

Shifting those dollars away from those who earned them in the private sector and away from the disciplining forces of prices, profits, losses, competition and consumer sovereignty, and handing them over to politicians to be spent according to political and governmental incentives mean that those resources are used far less efficiently, with growth undermined.

So, yes, a new tax on unrealized gains for the very wealthy will have very real effects well down the income scale, including the entrepreneurs who need funding to grow their businesses, as well as the individuals who would be employed by such businesses, and the consumers being served by these enterprises.

Whether it be this proposed destructive, unconstitutional income/wealth tax, the hike in the personal income tax rate, the rise in the corporate income tax rate, the higher capital gains and dividends tax rate, or other measures to increase tax and regulatory burdens by President Biden and various members of Congress, this is the explicitly wrong direction on policy.

President Biden Needs to Be Cutting Taxes and Indexing Capital Gains

Again, the president and Congress should be focused on pro-entrepreneur, pro-investment, pro-work, pro-growth policies. For example, if we’re going to look at capital gains, then policymaking shouldn’t be pointed in the direction of a greater tax burden, but quite the contrary, elected officials should be seeking to reduce burdens. Indexing capital gains for inflation would be a sound step, and by doing so, bring the capital gains tax in line with the personal income tax, which has brackets indexed. As SBE Council recently explained:

Unfortunately, capital gains are not indexed for inflation. That means that the real capital gains tax rate that individuals pay actually is higher than the stated nominal rate, which is 23.8 percent (20 percent plus the 3.8 percent Obama Medicare tax). And the hotter that inflation runs, the higher the real capital gains tax rate.

Let’s consider a few examples based on the fact that inflation (as measured by the Consumer Price Index) from January 2021 to January 2022 ran at 7.5 percent. If a person invested $1,000 in a business in January 2021 and sold it in January 2022, the gain, again, would be subject to the 23.8 percent capital gains tax.

Based on the return and the rate of inflation, the real capital gains tax rate changes.

Example #1: Capital Gains Tax Paid on a Real Loss. A $1,000 investment in January 2021 is sold in January 2022 for a gain of $50, or 5 percent. The capital gains tax paid at a rate of 23.8 percent would be $11.90. However, under this scenario and given the increase in inflation, it turns out that this investor is paying capital gains taxes on a real capital loss.

Example #2: A Real Capital Gains Tax Rate of 96.4 Percent. A $1,000 investment in January 2021 is sold in January 2022 for a gain of $100, or 10 percent. The capital gains tax paid at a rate of 23.8 percent would be $23.80. However, under this scenario and given the increase in inflation, it turns out that this investor is paying a real capital gains tax rate of 96.4 percent.

Example #3: A Real Capital Gains Tax Rate of 38.2 Percent. A $1,000 investment in January 2021 is sold in January 2022 for a gain of $200, or 20 percent. The capital gains tax paid at a rate of 23.8 percent would be $47.60. However, under this scenario and given the increase in inflation, it turns out that this investor is paying a real capital gains tax rate of 38.2 percent…

When it comes to starting up, building, operating and investing in businesses, the opportunity for significant returns, again given the levels of uncertainty and risk, must be present. The capital gains tax reduces such potential returns.

All of this, of course, would be made much worse with the Biden proposals.

WANTED: Sound Economic Thinking

While long overdue, President Biden and various Members of Congress need to put aside politics when formulating tax policies (as well as regulatory, trade and spending policies, for that matter), and deal with and be guided by sound economic thinking. If not, and policies like higher personal income, corporate income, capital gains, and wealth taxes are inflicted, then our economic recovery will be undermined, chances for recession will increase, and long-term growth will under-perform.

If President Biden has his way, the Biden economy promises to be quite grim.

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