US investors got a nasty tax shock yesterday: US president Joe Biden wants to increase capital gains tax. A lot.
He’ll be laying out the exact details next week. But suffice to say, if you’re an investor in America, sitting on a lot of paper profits, you might now be wondering if it’s time to take some money off the table.
So what might that mean for markets more broadly?
The capital gains tax rise is mostly about politics
Markets were pootling around minding their own business yesterday, generally trending higher, when about halfway through the US trading day (so near the end of ours), they swung sharply lower.
Why? Because Bloomberg reported that Joe Biden wants to almost double the capital gains tax rate (CGT) on the wealthy, to 39.6%, up from 20%.
When they say “wealthy”, by the way, we’re talking about people earning $1m a year or more. (A side issue, but something that struck me: just take a moment to think about how wealthy and successful America is as a country that tax brackets for people with annual incomes of more than $1m are not deemed ludicrously marginal.)
Anyway, the UK’s own CGT regime is intricate enough, so you don’t need to know the details of another country’s CGT rules. But the point is, this is a big jump. If you throw in taxes at the state level, then people in New York and California could be paying more than 50%.
Now, ultimately this is about politics: Biden wants to spend a lot of money. The MMT argument (to which politicians are increasingly sympathetic) is that you don’t need to raise the money elsewhere because the central bank can just print it anyway. (This is technically correct, by the way – it’s just that behaving in this way and setting such precedents can have other consequences).
But politically, it’s difficult to say “we’re just going to print the money”. So you can’t spend it without at least giving the impression that you’re raising it from somewhere else. In the end, the sums don’t matter that much as long as it can be made to look good in a forecast – or as long as they can be wielded in a negotiation with your rivals.
It’s a bit like the way in the UK, a vast amount of public spending over the past ten years has generally mostly been “paid for” by “closing tax loopholes”. Closing loopholes and a group generically referred to as “the rich” are the go-to sources of tax revenue because other voters don’t mind tax hikes on the rich, because no one thinks they’re rich.
Anyway – it might all be about politics, but clearly it has an effect of some sort. So what does this mean for markets?
Why this could be bad news for crypto
The main concern for markets about raising CGT is that it encourages people to crystallise their profits now, so that they don’t have to pay a higher rate. So the idea is that you get a wave of selling.
At first glance, history suggests this doesn’t matter much. Barack Obama pushed through a big CGT increase towards the end of 2012. The S&P 500 didn’t like it much at first, notes John Authers for Bloomberg, but after a few months of going sideways, 2013 ended up being a very good year for the stock market.
However, there is one group of stocks that tends to suffer – and this might be more relevant this time around. Data from Goldman Sachs, cited by Authers, notes that “the only lasting effect [of CGT hikes] appears to be on momentum stocks”.
That makes sense. Momentum stocks are the ones that have already gone up the most, so there are plenty of gains to crystallise – and they are also the ones where the gains come from capital appreciation rather than income.
So this is another reason to expect the “Great Rotation” to continue. That’s partly because it’s worse news for “hot” stocks than for lagging ones, and partly because it favours income stocks over growth stocks.
If you’re earning enough for CGT to be a big worry, then you are almost certainly someone who has the wherewithal to…