Capital gains and other forms of capital income represent the reward for placing investment capital at risk. Investment capital such as capital gains is a critical element as businesses seek to form and expand operations.
A capital gain is a measure of the rise in an asset’s value over time. In the usual case, a capital gain is the difference between the amount received when an asset is sold and the asset’s basis, which is the asset’s cost or purchase price plus allowable adjustments such as depreciation and the value of improvements. Businesses and individuals may both be subject to taxes on their capital gains. Typically, capital gains are taxed only when an asset is sold.
The United States currently has one of the highest long-term capital gains tax rates, at 29.7%, ninth among the 38 Organisation for Economic and Co-operation and Development (OECD) countries and Brazil, Russia, India, and China (collectively referred to as BRIC countries). The U.S. capital gains rate is comprised of several elements, including the long-term federal statutory capital gains tax rate, net investment income tax, and state-level capital gains taxes. Short-term gains are generally taxed as ordinary income. Under current law, when a business owner dies, the assets are transferred to heirs untaxed and the basis for future capital gains on such assets is increased or “stepped up” to the present fair market value without payment of capital gains taxes.
There are, however, policymakers who support raising the capital gains tax rate despite the U.S. having one of the highest rates in the world. In particular, the Biden administration’s Fiscal Year (FY) 2022 Budget includes three provisions that would drastically increase long-term capital gains rates in the United States. Those three policy proposals would
1. tax long-term capital gains as ordinary income for taxpayers with incomes over $1 million,
2. increase the top ordinary income tax rate from 37% to 39.6% (on long-term capital gains), and
3. repeal the step-up of basis and tax capital gains at death.
In the case of capital gains accruing on corporate equities, the tax impact of capital gains should account for the double taxation of corporate income. The integrated capital gains tax rate reflects both the corporate income tax on corporate earnings and capital gains taxes (and dividend taxes) imposed on shareholders. The FY 2022 Budget would also increase the corporate tax rate from 21% to 28%, which impacts the taxation of corporate earnings that ultimately are taxed as capital gains.
This report compares the top longterm capital gains tax rates in the U.S. with those of the OECD and BRIC countries based on both current rates and under a scenario where the U.S. adopts the proposals in the Biden administration’s FY 2022 Budget. This report also estimates the macroeconomic impacts of the capital gains proposals on key areas of the U.S. economy.i1 While proponents of capital gains tax rate increases contend that only a few Americans would pay or remit the higher taxes, in actuality, many Americans and businesses would feel the effects through the taxes’ impacts on jobs, wages, and gross domestic product (GDP). Existing taxes on capital gains discourage domestic savings. The increase in capital gains taxes proposed in the FY 2022 Budget would leave the U.S. with the highest top capital gains tax rate among OECD and BRIC countries and a top tax rate that is 30.6 percentage points (two and half times) the average, further discouraging domestic saving and the potential for investment in American businesses.
Download the full report below.
