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What Holds for ETFs If Biden Hikes Capital Gain Tax?

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As has been discussed for over a year, President Joe Biden is now likely to propose a plan to raise taxes on the richest Americans, including the largest-ever increase in levies on investment gains. This would be to finance about $1 trillion in social spending that serve childcare, universal pre-kindergarten education and paid leave for workers, per sources.

The new marginal 39.6% rate would be a substantial increase from the current rate of 20%, for those earning $1 million or more. This on top of an existing surtax on investment income, will lead federal tax rates for wealthy investors to as high as 43.4%, per a Bloomberg article. If applied, this would be the highest tax rate on capital gains since the 1920s. The rate has not surpassed 33.8% in the post-World War Two era, as quoted on a Reuters article.

There are some states and cities that assess their own capital gains’ levy. Biden's latest plan would drive the total capital gains rate in those areas to more than 50%, said Erica York, an economist at the Tax Foundation, as quoted on Reuters. The rate would shoot up to 56.7% in California, 68.2% in New York City and 57.3% in Portland, Oregon, per York.

York also indicated that if passed, U.S. capital gains taxes would probably be the highest in the globe. Average capital gains taxes in Europe are around 19.3% with the highest rate (42%) applicable in Denmark, per the Reuters article. Notably, the latest investment gain tax plan is part of the White House's drive for a drastic refurbishment of the U.S. tax law (read: ETFs to Follow If Tax Hike Comes After $1.9-T Biden Stimulus).

Will Tax Law Change At All Happen?

Investors should note that any such tax hike would need support from Congress, where Biden's Democratic Party holds slim majorities. Such proposal by Biden is unlikely to get the green signal from Republicans as the latter had cut tax rates substantially in their/Trump’s rule.

It is also uncertain if Biden’s proposal would win the unanimous support from congressional Democrats, which is a must-have in the Senate to turn any changes into a law. There is news that Centrist Democrats in Congress are opposing Biden’s tax proposal. A resistance from centrist Democrats might make the actual capital gain tax rate well below 39%.

A Hike in Capital Gains Taxes Means a Tepid Wall Street for the Short Term

Increase in the capital-gains tax could result in a large-scale stock selloff, according to economic analyses, as quoted on CNBC. In 1986, as part of the Reagan tax plan, the top rate for capital gains surged from 20% in 1986 to 28% in 1987. Just before the hike, capital gains’ realizations shot up by 60%, the CNBC article noted. An overall stock market selloff means a short-term rough patch for the likes of iShares Core S&P Total U.S. Stock Market ETF ((ITOT - Free Report) ).

However, the hike in the same should not impact the markets over the long term. An increase in capital-gains taxes would surely impact stock-market valuations. Investors may only be willing to pay a lower multiple for near-term profits as the after-tax return would be lowered, per a article. But that should not suppress the entire market momentum.

In 2013, the S&P 500 added about 30% despite the nine percentage-point increase in capital gains tax rate. In 1981, the tax rate dropped about eight percentage points, but the S&P 500 skidded 10%, Barrons’ article noted.

ETFs in Focus

Against this backdrop, below we expect the medium-to-long term bet on the S&P 500 ETFs to be worth. These ETFs are Vanguard S&P 500 ETF (VOO - Free Report) , iShares Core S&P 500 ETF (IVV - Free Report) , SPDR S&P 500 ETF (SPY - Free Report) .

However, private equity ETFs like Invesco Global Listed Private Equity ETF (PSP - Free Report) may be under trouble as Biden’s proposal to would lower “the favorable tax treatment on so-called carried interest, which is the cut of profits on investments taken by private equity and hedge fund managers,” as indicated by a Bloomberg article.

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