June 21, 2021

It is possible that as the Biden Administration argues, the higher tax rates will generate higher revenues that will be deployed in “investments” that lead to an increase in economic activity, and overall economic productivity. We hope the Administration succeeds because a rising tide lifts all boats and prosperity cures many social and economic ills. Yet hope is not a strategy nor a forecast. The analysis presented here suggests that the tax rate increases proposed by the Biden Administration will have several adverse effects on the economy. One being a lower not a higher asset valuation. Another being that to minimize the effects of the tax rates, the so-called substitution effects or behavioral changes will be generated. In some cases, the tax code will favor long holding periods and investors will do so to avoid or minimize the tax on reinvestment of funds. If that is the case, it follows that capital may be trapped and not deployed efficiently for tax reasons. That in turn could lead to a slower growth and slower productivity gains. Although the Biden administration economic analysis publicly minimizes the substitution effects, the administration actions suggest that they are aware of the substitution effect and the possibility that they could have a large impact on the economy and have taken steps to minimize them. One being attempting to make the proposed capital gains tax increase retroactive. The goal here is to prevent people from taking advantage of the timing, i.e., the acceleration of the capital gains realizations to minimize their capital gains tax liabilities. Another step is the so called “harmonization” of tax rates. By raising the top rate on capital gains and applying it to accrued gains. The Biden Administration effectively wants to implement a reinvestment tax rate on accrued gains, much like the taxes on dividends. Such harmonization will have a negative impact on the incentives to save and invest. As we already shown, it could lead up to a 39.6% decline in the value of a long-term capital gains income stream. Lower valuation leads to lower rates of return which in turn lead to lower savings and, lower real GDP, and lower productivity. The impact is on the economy is larger longer the longer the tax structure remains in place. A “new new normal” while livable in the short run, it is not what we are striving for. We can and should do better than a “new new normal".

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