Should Investors Worry About Possible Changes to Capital Gains Tax Rates? | 7investing
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Should Investors Worry About Possible Changes to Capital Gains Tax Rates?

April 23, 2021

Americans generally pay a lower rate in capital gains tax when they hold an investment at least year. If you sell a stock in less than a year, you’re taxed on any gains as income, which for most investors, would be at a higher rate.

Now, there have been media reports that President Joe Biden wants to increase the long-term capital gains tax for people who make over $1 million a year. There’s no guarantee that will happen but a change in the long-term capital gains rates would impact more than just the wealthy people paying the higher rates.

Matt Cochrane and Simon Erickson joined Dan Kline on the April 23 “7investing Now” to talk about the implications of  any potential capital gains tax changes.

A full transcript follows the video.

 

Dan Kline: But let’s segue to What We’re Watching. President Biden wants to increase the capital gains tax that’s sort of came out as a rumor yesterday, the planned increase would would be to essentially the income tax rate, but only for people making over a million dollars a year. Matt, this sent markets tumbling yesterday, can you first to sort of explain what capital gains is and then explain sort of why this happened yesterday?

Matt Cochrane:  Sure. Yeah, absolutely. So a capital gains tax is just a tax on the growth and the value of your investments incurred. So like whenever, and it’s only it’s only it’s not charged for when, when gains are unrealized meaning like when you hold an asset, like it can go up for forever, and you’ll never be charged a capital gains tax for that. It’s only charged when you when you sell that asset. So for like stocks, like um, you know, if you you hold a stock X for 100% gain, and you sell, you’re taxed on those gains. Now, what Biden is proposing is for, like you said, Dan, is for income earners that earn more than $1 million a year, and they’re proposing to raise the rate from about 24% to about 44%. So it is a substantial gain?

You know, like really only only two things I would add, Dan, so like, Look, first of all, look, whether this is good, like a good thing for incoming inequality, or, or raising money for infrastructure or anything like that, I’m gonna stay out of that. That’s like above my paygrade. It’s just questions that, you know, everybody can come to their own conclusions, though.

The one question I do want to focus on is, is this good for stocks? And look the answer to that? And it’s, I think it’s okay to say the answer is no, I think all too often, government policies, and politicians get way too much credit, whether good or bad for the stock market, but one lever they can pull is tax rates. And when taxes go up on the selling of an asset class, like stocks, you can expect that to be a headwind, for for that asset class.

But like, the second thing I want to add is like, should that change your investment strategy? You know, even if, even if that does affect you, even if you do fall in that income range, which obviously won’t be for most people. But if you do fall in that asset class, like if you do fall in that income range, should that shrink your investment strategy? Absolutely. We should change everything? No, of course not. You should still be looking for companies with competitive advantages and growing markets at decent valuations and hold for the long term.

Dan Kline: I also expect and again, this is not an official plan, this was sort of floated out there. I feel like this is a trial balloon to see sort of what the public pushback is. And what people are missing is that if you are a multi-millionaire, you have options. You don’t have to invest in the stock market, you can do other things with your money. Keeping that money out of the market, Matt, that’s not good for Joe little guy. Right. And I’ll include myself in that that list. We want sort of as much money put into the market as possible within reason.

Matt Cochrane: Yeah, absolutely. Yeah, absolutely. And like, you know, I’ve I do wish the political class would like, would recognize, like make a bigger recognition, for like short term capital gains, taxes and long term gains. You know, like, today on Twitter, I forget who but somebody suggested, like, you know, how about no capital gains taxes for, for for assets held over five years?

You know, I would love to see like, more thinking like that more encouragement, more incentivizing for for long term holding of stocks or any asset really, but like, you know, and more of like, you know, for for day traders and things like that, like, that’s more speculative market and not an investing market. Um, you know, I wish there was more of a distinction made, you know, but, but yeah,

Dan Kline:  I think it’s part of the reason 7investing exists, and I’m going to bring Simon into this. Most people in Congress are wealthy and when you’re wealthy, I think you think the stock market is something only wealthy people can use. And here’s the reality, the average person has exposure to the stock market in their 401(k). I don’t know the percentage of Americans who have a 401(k). But it’s reasonably high.

Matt Cochrane:  And pensions.

Dan Kline:  And pensions. But what we’re doing here at 7investing, is we’re telling, you know, I talked about this a couple weeks ago, I met with a 17 year old, who has a very small amount of money, but he’s going to steadily invest in the market, we want to tell anybody that they can be in the market, and they can take advantage of these gains. And we also want to tell them that we hope they can become a millionaire because of it. I am pretty sure raising the capital gains tax on long term capital gains disincentivizes people from going into the market, and that can have a catastrophic, you know, effect Simon.

If you take $100 a month and put it in a savings account, or a CD, or lots of, a bond, your returns are going to be abysmal, even at historic highs, they are going to underperform the market. So how do we get government, and Simon I’m gonna let you answer this impossible question, because there’s no answer for it. How do you get government to understand that we should be encouraging the stock market as a way to create wealth, not just something for the wealthy?

Simon Erickson:  Well, I think it comes back to Matt’s point that he made that the there’s evolution and innovation and how people are saving money, you know, we from the 401(k) plan that was launched, and then you had the Roth IRA in 1997. You know, there were there has been regulations that have encouraged people to save money to pre-tax or after-tax in to taking care of yourself later in life.

And that gives you not only the burden, which some people see it as a burden, I see it as an opportunity to break away from, you know, the small chart that says, here’s your four options, you can invest your company’s 401(k) plan, now you can go out and actually buy individual stocks, and you’ve got access to so much more information to your point

Dan, that is why 7investing exists. And so maybe we don’t let the tail wag the dog on this one, you know, tax rates are going to be what tax rates are going to be, I think bigger picture when you’re thinking about this over decades, you want to be investing in the stock market, you want to be more actionable in taking control of your financial future.

Dan Kline: Joyce Heinz. I’m gonna I’m gonna take your comment as “meaning all politicians, they understand, but they don’t care”. I actually don’t think that’s true. I think we saw this with the internet hearings. You know, when when Facebook and the other tech companies came in and spoke to Congress, I think you’re largely speaking to old people. And I’m not sure you know, we had that litmus test for a million years, when we’d ask presidential candidates the price of a gallon of milk.

I’m not so sure the average person in Congress understands what a family making $80,000 a year is doing, what they’re investing, and that they could be making money in the stock market. And that, you know, if the government cared or understood investing, it would be taught in schools, and it’s not there is not basic financial literacy taught in most schools in this country. So I do think it’s a whole, Matt Cochrane, you wanted to chime in?

Matt Cochrane:  Yeah. And to your point, Dan, about like the middle class, like being being invested in the stock market, like, you know, you’ll you’ll only see those statistics that show like, you know, the top 2% of, you know, net worth individuals own, like, 80% of the stock market or things like that.

And, of course, right. I mean, like Jeff Bezos alone owns about, like, approximately 80 gazillion dollars worth of Amazon stock, you know, Bill Gates owns a gazillion dollars, you know, of Microsoft stock still, you know, Warren Buffett owns a gazillion dollars of Berkshire Hathaway stock. And it takes a lot. I mean, it takes like, hundreds of 1000’s, or maybe even millions of, you know, middle class investors to even match one of those. Right.

But as far as like a percentage of the middle classes net worth, like is in the stock market. It is there. Like I mean, I work at a municipality, where everybody’s into the pension plan, that pension plan is invested 60% into the stock market, you know, 401(k)’s are huge. I mean, so, so those kinds of stats, I think, like it get thrown around too much and taken out of context. And, you know, they don’t tell the story that like, that’s true, because people like that alone will like throw off that that that average, but the middle class is definitely 100% invested in the stock market.

Dan Kline:  And I think it’s important to remember and I’ll sort of take the last word here, though, we’re going to take a couple of comments from Ravi Shah, Sam. So one, one functional one, one about this, but when the government is doing anything, it’s a negotiation. We have we have a two-party government.

So the President is leaking out that this is what he wants. There could be pushback, and that pushback may be well, we won’t have an increase in the capital gains tax, but we will revert income tax rates, which affects short term capital gains. And so this is likely a negotiating ploy. I actually don’t see this as a serious political play. You might see people over a million dollars, the rate tweaks up a few points or, you know, even then it becomes very difficult because like, Okay, this year, I only made $900,000, I’ll sell a whole bunch of stocks. And there’s ways to engineer your income. So it doesn’t look like you made a million dollars that year, we don’t want to add that layer of complexity to these transactions.

So I really do think you’re going to probably see an attempt to revert some of the previous tax cuts on very, very high income earners. I doubt this is going to go through. But remember, the stock market often reacts very, very harshly to very minor short term news, the possibility a politician might try to do something is not actually a news story. It’s the beginning of a new story. And that’s kind of what this is here.

We’re going to talk in a minute about AI. But before we do that functional question from Ravi Shah, “as members, are we supposed to get emails when subscriber calls happen?” Yes, we do send out emails. We don’t over email you we only send out what is it Simon, maybe at max two emails a week.

Simon Erickson:  You can actually opt into more of those if you want. And Ravi, thank you for this question. We do the week-of the subscriber call, we send out an invitation for everyone who’s currently subscribed to 7investing, you do have to opt in in your profile if you want to receive our emails. But as long as that’s checked, and you’re opted in, you will get an invitation for basically the third Friday of every month. That’s when we host our subscriber calls.

Dan Kline: So if you’re a member and you are not getting those invitations, shoot us an email at info@7investing.com and Steve Symington will absolutely take care of that. But let’s take Ravi’s second comment to close out this topic. If you can bring it up Sam Bailey, “The more you sell, the more taxes you pay. So I would think government would care more about short term capital gains tax than long term”, Matt, am I correct in saying short term capital gains is just income?

Matt Cochrane:  Yeah, I think I think that’s Yeah, basically, I think that’s correct. Yes.

Dan Kline:  So I do think you might see tweaks to the income tax rates. And I actually think it’s a great thing, if you disincentivize short term selling if you if you make it so people hold stocks, one, they’re going to consider them more carefully, you’re not going to get this, you know, retail mania buying that we’ve seen, you’re actually going to see more people seek out good companies and buy and hold them. Stability is actually really good for the stock market.