Capital Gains Tax Hikes do not Just Affect the Rich

Taxing the non-wage income of the wealthy is politically popular because it is assumed few people will be affected. President Obama’s 2016 budget proposes an increase in the capital gains tax to 28 percent for couples earning $500,000 or more, says Pam Villarreal, senior fellow at the National Center for Policy Analysis.

This is estimated to increase revenue about $208 billion over 10 years. In his State of the Union address, Obama noted the Reagan administration established the same rate, as if to minimize the effects of the proposal. But the comparison is not apt; President Reagan lowered marginal tax rates during his tenure, and there was no Medicare tax on unearned income, as there is now. What would be the effect if the capital gains tax increased from its current 20 percent to 28 percent?

Consider a couple earning more than $500,000. Suppose the couple owns $50,000 of stock that has accumulated an 8 percent capital gain and 3 percent dividend after one year. The total pretax rate of return on the $50,000 investment (sold after one year) would be 11 percent. However:

– With the current capital gains tax rate of 20 percent plus the 3.8 percent Medicare tax, the tax on a $50,000 stock sale would be $1,309, and the after-tax rate of return would be 8.4 percent.
– If President Obama’s proposed capital gains and dividends rate of 28 percent were in effect, the couple\’s tax bill would increase to $1,749 and the after-tax return would fall to 7.5 percent.
– If the dividends were nonqualified and taxed at the ordinary income tax rate of 39.6 percent, the couple’s effective (average) tax rate would increase from 29 percent to nearly 35 percent, and reduce the return on investment by two-thirds of a percentage point to 7.2 percent.

Capital gains tax hikes do not just affect the wealthy; they affect anyone at any income level who needs access to capital. In today’s struggling entrepreneurial climate, policymakers can ill-afford to impose additional taxes on productive workers and small businesses, or reduce the rate of return on capital investment.

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