Investors have been warned of new and higher taxes from the Biden administration. The political climate makes some possibilities easier, others harder, and all more confusing.
As we approach two years into the COVID-19 pandemic, for many it has been a time to reflect on our priorities, our loved ones, and those we’ve lost. One inspiring musician who died of complications from COVID-19 was the great folk singer–songwriter John Prine. In his last known recording, Prine joined R&B veteran Swamp Dogg for a song titled “Please Let Me Go Round Again,” in which two old men quizzically reflect on a life surrounded by missteps: “If you let me go round again, I’ll build a better mousetrap from a far better plan.”
As we look ahead to 2022, we’re first required to go round and look back at the tax mousetrap designed in 2021, however unwelcome the review may be. Tax policy played an outsized role for investors, but it shared the spotlight with plenty of other geopolitical dramas.
How will the Biden administration’s agenda affect taxable investors?
President Joe Biden’s administration was never going to enjoy smooth sailing. Proposed tax increases are always politically unpopular and usually controversial. However, the Democratic Party also had to contend with its underperformance in the House and Senate on Election Day 2020—meaning that despite technically controlling all three chambers, they’d need to pare back an ambitious social agenda. Important election runoff wins in Georgia offered some hope, if fragile, that at least part of Biden’s plans could be accomplished. But a supermajority to pass legislation via standard congressional mechanics wouldn’t be possible. Biden’s team would need to seek consensus among congressional Democrats.
Timeline of Biden’s 2021 legislative agenda
Fast-forward to October 2021 and the off-year election in early November. The Build Back Better (BBB) Act had just been dealt a blow by Arizona senator Kyrsten Sinema, who revealed that she would oppose raising both income tax rates and capital gains tax rates, requiring the act’s sponsors to seek other tax revenue sources. A second successive year of Election Day underperformance served as a swift reminder to Democrats that they needed to get their act together—and quickly. The Bipartisan Infrastructure Deal passed before Thanksgiving, and the BBB package passed the House and moved to the Senate in December. But it was far from finalized, needing support from moderate and progressive Democrats. As Christmas approached, West Virginia senator Joe Manchin confirmed that he wouldn’t support the legislation, postponing the vote until later in 2022 or perhaps indefinitely.
Select 2021 tax policy proposals
One interesting episode amid the turmoil was a day in the spotlight for taxes on wealth, also known as the Billionaires Income Tax or simply the billionaires tax. The plan, proposed by Oregon senator Ron Wyden, identified fewer than 1,000 individuals with substantial wealth tied to marketable securities and suggested this targeted approach could raise significant revenue. Although it appeals to much of the public, practical considerations raise questions: It may be an unstable and unpredictable source of tax revenue, and it may come with certain frictions and unintended consequences. These taxpayers would be highly motivated to avoid the tax by pursuing residency abroad or by avoiding publicly traded assets in favor of private ownership, where valuation is more cumbersome. Ultimately the plan never made it into the House Ways and Means Committee’s formal legislation, ostensibly for questions of constitutionality, specifically the 16th Amendment’s reference to direct taxes on “income” and not “wealth” or “assets.”..
Nonetheless, a rallying cry to tax the rich remains popular among the majority of Americans. Reporting last year by ProPublica highlighted the ease with which the ultrawealthy can manage their tax bills by borrowing against their shares to finance their lifestyle, despite paying themselves only a courtesy salary or no salary at all. Taxpayers should expect to hear calls for some form of a wealth tax in 2022 and beyond.
If funding sweeping social programs is a top priority, Democrats could alternatively propose taxes broader than just targeting a few hundred wealthy individuals. A broader tax mousetrap might consist of a combination of existing income taxes, a global minimum tax on corporations, a value-added tax, or a modest tax on all listed corporate shares.
What can students, workers, and retirees expect?
Amid 2021’s busy legislative calendar, one of the more overlooked pieces of legislation was the House’s so-called SECURE Act 2.0. This bill, which quietly passed the House on a bipartisan unanimous voice vote in May, broadly aims to increase participation in retirement savings programs. The provisions in the bill and its partner proposal—which hasn’t yet passed in the Senate—include higher catch-up contributions and an increase in the age for required minimum distributions for older investors. For younger investors, the act proposes default enrollment in employer-sponsored plans and employer-matched contributions for employee student loan payments. We expect the Senate to address and modify this proposal in 2022.
The bottom line
A divided political climate muddies the waters and makes paradigm shifts difficult, as the BBB plan proved. Until either party has a supermajority or both parties can agree on how to build that better mousetrap—or whether we need a better mousetrap in the first place—we’re left with a tax revenue and spending quagmire. The upshot for 2022 is that not much has changed for the taxable investor:
- The highest federal marginal income tax rate remains unchanged at 40.8% after including the net investment income tax surcharge, which continues to make tax-loss harvesting valuable.
- The large difference between income tax rates and long-term capital gains rates allows for the valuable deferral of short-term capital gains.
- Estate tax exemptions left intact—at least until they expire in 2026—make tax planning simpler and more beneficial.
- The step-up in cost basis at death left intact means investors are incentivized to defer gains for as long as is practical, depending on the investor’s unique circumstances.
Given these facts, the value propositions of direct indexing remain largely unchanged. We encourage investors to harness the power of year-round tax management and make sure they’re getting the most out of their taxable investments.