What Will the Capital Gains Rate Be in 2013?

By :: April 7th, 2010

My best guess is that the top tax rate on capital gains and dividends in 2013 will be almost 24 percent—a significant increase over today’s 15 percent rate. As a result, the decade-long tax holiday for investors is coming to a gradual end. 

At the moment, the fate of all of these tax rates is a bit uncertain. But here is the recipe for big tax increases on investments: Take the tax hikes included in the newly-enacted health law. Combine with other tax changes President Obama has proposed in his 2011 budget. Add huge deficits and the scheduled expiration of the Bush tax cuts in less than nine months. The result is likely to be a big increase in taxes on capital, at least for the wealthiest investors.

Here are the numbers: The top rate on gains and dividends today is 15 percent. If Congress does not act between now and Dec. 31, the maximum rate on capital gains will rise to 20 percent, what it was back in 2001. The top rate on dividends will soar to 39.6 percent, its level prior to those 2001 Bush tax cuts.

Obama has proposed a 2011 tax on investment of 20 percent for both dividends and gains. But remember, the new health law includes an extra Medicare tax of 3.8 percent on investment income starting in 2013. The two changes combined would raise rates on investments to nearly 24 percent, at least for couples making more than about $250,000 and singles earning about $200,000.

Btw, even at 23.8 percent, capital gains rates would still be lower than the post-war average, which my colleague Eric Toder figures has been about 25.5 percent.  And initially, the top rate on investment income would apply to only about 2 percent of taxpayers, although because the income triggers are not indexed for inflation, the higher rate gradually would hit increasing numbers of taxpayers.
  
Even as Obama raises investment taxes, he’d also boost rates on ordinary income--back to 36 percent and 39.6 percent for those in the top two brackets. He’d also restore the phase-outs of the standard deduction and the personal exemption for high-earners (another reversal of the Bush tax cuts). These changes would increase their marginal rates by another percentage point or so. As a result, the difference between rates on investments versus ordinary income will shrink somehwat for top-bracket taxpayers.

Obama could scale back these rate hikes on investments, but he has given no signs that he is planning to do so. For the past couple of weeks, I’ve been trying to get Administration officials to clarify what their preferred rate would be on gains and dividends, but they’ve been unusually silent on the topic. So in the absence of a response, I’m going to assume Obama still favors his own budget proposal.

What will be the impact of all this? First, keep in mind that when it comes to capital gains, timing is everything. Unlike, say, wage income, it is easy for investors to decide when to sell stock or other assets. So taxpayers close to the income triggers for these higher rates will accelerate gains into this year to take advantage of the last days of low rates. They may do the same thing in 2012, just before the next rate hikes take effect. Once the higher rates kick in, they may try to defer income in an effort to stay below the high tax thresholds.  

Timing aside, higher rates on investment income may increase the cost of capital for businesses (a bad thing) and limit the attractiveness of tax shelters (a good thing).

Will these tax hikes come to pass? As I’ve written recently, it is very hard to predict what tax rates will be in three years. But we’re getting a pretty good idea of what the administration would like them to look like. And, for wealthy investors, it is not a pretty sight.  

5Comments

  1. Anonymous  ::  4:20 pm on April 7th, 2010:

    24% is still too low. When Clinton lowered rates toward the end of his second term, the tech bubble was a result. When Bush lowered them twice, we got all sorts of bubbles. When tax rates on capital are lower than they are for labor, you will get more capital and less compensation for labor. People will buy other companies rather than expanding their own. This is definitely not a good thing and is why we need a VAT (or two) and a high income surtax with a uniform rate.

  2. Anonymous  ::  9:53 am on May 3rd, 2010:

    I honestly think that the capital gains rate will pass over 24% just like Michael said. With this taken situation I don't know what will come of us. I'm lucky because I work for a finance Dallas companie and it's going well at the moment but you will never know what the future will bring.

  3. Anonymous  ::  11:09 pm on May 6th, 2010:

    I have a $2.4m carryforard loss to absorb, so I am not too bothered by Capital Gains.
    However, it is one of the worst motivated taxes. I am guessing it results in very littel tax revenue, and is principally about wealth redistribution from the winners to the losers.
    It is easiest to see this by considering options. Options have a finite liftime, and expire. Options are exactly a zero-sum gaome, that is one mamn's gain is another man's loss. So the goverment makes (ot should make)net zero by taxing options. Now with stocks, it's not a zero sum game, but the increase in the value of a stock can be due to either inflation, or just godd business; either way, what right does the govermenet, with nothing invested in it, have to a cut of the profits? None whatsoever.
    Now dividends are intersting. Dividend tax plus corporate tax is clearly double taxation. Now, you can always convert a dividend to capital gain like this: Sell the stock the day before ex-div and buy ir back the day afterwards at a price that is lower by the just foregone dividend. So that says dividends and short term capital gains, at least, sould be netted and taxed identically, unless erased by losses.
    Now we come to corporate taxes. If a company borrows money from the bank and pays interest on it, does the comapny have to the interest out of taxed profit, or does it get to deduct the interest as an expense? The latter of cours! Now, hwne the company raised finance from its shareholders and pays them a dividend, why isnl;t the dividend also a deductibel expense – the cost of capital?
    If we allowed dividends to bev treated like interest payments as an expense, you could cut the tax code in half just about. We would no longer need differet tax rules for mutual funds, C-coprs, S-corps REITs, Trusts etc. The rule would be simple: The proportion of your gross profits you pay to shareholders would be taxed upon receipt by the. Retained profit would be taxed ay a coroprate rate that would be an estimated mean tax rate of all shareholders/taxpayers. Shareholders would be allowed to increase their basis in the stock by the amount of retaine dprofit on which coroporate tax had already been paid, so that their capital gain is reduced upon a later sale.
    The US is so far from a fair, just and mathjematically taxation of wealth creating activity, it is no wonder that it is headed down the toilet. The result of reforms will be much lower tax revenue, and Congress will just have to stop spending othe people money, period – that's the only solution – before they6 are forced into that by a Greek-style tragedy.

  4. Anonymous  ::  7:44 pm on June 17th, 2010:

    According to current numbers from Treasury, capital gains taxes paid in 2004 totaled $73.6 Billion, in 2003 $51.3 Billion, in 2002 $49.1 Billion and in 2001 $65.7 Billion (although the data stretches back to 1954). You have to draw your own conclusions on whether this level of tax revenue is significant.

  5. The case for raising taxes on capital gains  ::  11:06 am on September 25th, 2012:

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