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Why Raising Taxes on the Wealthy Won't Solve America's Economic Woes

by Bryan Sarff, Personal CFO at intellicents

Recently, President Biden has proposed raising the tax on capital gains and overall income taxes to increase government revenue. Professor Scott Galloway from NYU's Marketing Department has also discussed how Gen Z is being burdened by the need to support social security and Medicare for those over 65. Both Biden and Galloway argue that wealthy individuals are hoarding money, driving up stock prices, and that higher taxes on capital gains and income are necessary. However, this perspective overlooks several critical factors and misattributes the root causes of economic issues.



The Real Drivers of Inflation

During the Great Financial Crisis (GFC), approximately $9.58 trillion was spent to stabilize the economy. During the COVID-19 pandemic, this figure ballooned to around $19.64 trillion. This massive injection of funds is a significant driver of the current inflationary pressures. According to Forbes, the Biden administration's fiscal policies, including substantial spending, have contributed to inflationary trends.1, 6


Impact of Federal Reserve Policies

The Federal Reserve's decision to maintain extremely low interest rates, which drove 30-year mortgage rates below 3%, significantly inflated housing prices. As reported by Bankrate, these low rates have made homeownership more expensive, contributing to the housing market's current state.2 When the Federal Reserve cuts rates later this year, it is likely that home prices will rise even further, exacerbating the affordability crisis.


Rising Property Taxes and Insurance Costs

Homeowners are also facing increasing property taxes and insurance premiums. Property taxes surged by 7% in 2023, with further increases forecasted for the coming years.3 Homeowners insurance rates have also risen dramatically, with some states experiencing increases of up to 63%.4 These rising costs are placing additional financial burdens on homeowners, making it increasingly difficult to maintain homeownership.


Misguided Tax Proposals

Professor Galloway's suggestion that the government should redistribute wealth by raising capital gains taxes is flawed. The notion that the government can allocate resources more efficiently than individuals is debatable. Wealthy individuals often invest in businesses, donate to charitable causes, and pay significant taxes. Increasing taxes on capital gains could discourage investment and slow down economic growth. According to the Tax Foundation, Biden's proposed tax increases could push the top marginal rate on long-term capital gains to 49.9%, the highest in the OECD.5


Historical Context and Economic Theory

Historically, no government has successfully taxed its way to prosperity. The Laffer Curve illustrates that beyond a certain point, higher tax rates can lead to decreased revenue as economic activity slows. The current combined federal and state government spending is around 36% of GDP, significantly higher than the historical average of 18%.1 This excessive spending is a primary driver of inflation and economic instability.


Government Policies and Economic Consequences

In my opinion, the government's role in the economic challenges since the GFC includes:

  1. Pre-2008 Housing Policies: Policies that made it too easy to buy homes contributed to the 2008 financial crisis.

  2. GFC Spending: The $9.58 trillion spent during the GFC (2009 – 11) allowed companies to survive that should have failed, distorting market dynamics.6

  3. Low Interest Rates: The Federal Reserve's near-zero interest rates led to a housing price surge, increasing property taxes and insurance costs.

  4. COVID-19 Spending: The $19.64 trillion spent during the pandemic (2020-22), combined with lockdowns, created long-term economic disruptions.6


Conclusion

Blaming wealthy individuals for economic issues and advocating for higher taxes on capital gains and income is a simplistic and misguided approach. The real culprits are excessive government spending and misguided monetary policies. To address these issues, they need to focus on reducing government spending, encouraging investment, and fostering a stable economic environment.


What You Can Do as a Wealthy Individual if Tax Rates are Increasing:

  1. Tax-Efficient Investing: Work with an active advisor to purchase more buy-and-hold ETFs or stocks and hold or limit selling until, hopefully, the cap gains taxes change. (Mutual funds pay taxes on their gains each year.)7 Remember, you can always use assets subject to capital gains as collateral to borrow money from the bank at possibly better terms than paying the tax. Working with an advisor, build a spreadsheet to understand the breakeven analysis.

  2. Tax-Loss Harvesting: This involves selling investments at a loss to offset gains from other investments, thereby reducing the overall taxable gain. You can also be more proactive in volatile markets by looking at this more than once per year.8

  3. Maximize Savings to Retirement Accounts: As much as possible, save the max to your 401k, 403b, TSP, and IRA accounts. Your contributions go in pre-tax, and the tax is deferred until the money is withdrawn.9

  4. Maximize Health Savings Accounts (HSA): These are a favorite. Contributions to HSAs are pre-tax and they can be invested for tax-free growth. Spending the funds on qualified medical expenses is tax-free, and after age 65, any spending is taxed at your then current tax rate.10

  5. Donating Appreciated Assets: Donating stocks or real estate that have appreciated in value to a charity can help avoid capital gains taxes on those assets while also providing a charitable deduction.11

  6. Advanced Tax Planning Trusts: Utilizing various types of trusts, such as Intentionally Defective Irrevocable Grantor Trusts (IDGTs) and Charitable Remainder Trusts (CRTs), can help manage and reduce tax liabilities.12

  7. Family Limited Partnerships (FLPs): These can be used to transfer wealth to family members while potentially reducing estate and gift taxes.13

  8. Placing Investments in the Right Accounts: Tax-efficient investments (e.g., index funds, ETFs) should be placed in taxable accounts, while investments that generate significant taxable income (e.g., bonds, REITs) should be placed in tax-advantaged accounts.9

  9. Selling During Low-Income Years: Timing the sale of assets to years when income is lower can result in a lower capital gains tax rate.7

  10. Like-Kind Exchanges: For real estate investors, using Section 1031 exchanges allows the deferral of capital gains taxes by reinvesting the proceeds from a sold property into a similar property.14

  11. Investing in Municipal Bonds: Interest from municipal bonds is typically exempt from federal income taxes and, in some cases, state and local taxes, making them a tax-efficient investment for high-income individuals.15


By employing these strategies, wealthy individuals can effectively manage their tax liabilities and preserve more of their wealth.


Sources

1 Forbes: "Under Biden Tax Plan, Capital Gains Tax Will Exceed 50% In 11 States"

2 Bankrate: "Federal Reserve Interest Rates And The Housing Market"

3 Forbes: "Single-Family Property Taxes See 7% Jump in 2023"

4 CNBC: "Homeowners insurance rates skyrocketed in these 10 states"

5 Tax Foundation: "Biden Budget Tax Proposals: Details & Analysis"

6 Statista: “Total outlays of the US Government in fiscal years 2000 to 2029”

7 Bankrate: “Tax-efficient investing: 7 ways to minimize taxes and keep more of your profits.”

8 Time: “Everything You Need to Know About Tax Efficient Investing.”

9 Schwab: “Tax-Efficient Investing: Why Is It Important?”

10 Investopedia: “Why You Should Consider an HSA Even If You're Not Rich”

11 Investopedia: “Safe Tax Planning For High-Net-Worth Filers”

12 Cunningham Legal: “Advanced Tax Planning Services for High Net-Worth Families.”

13 Forbes: “How To Protect Your Assets From Lawsuits Or Creditors”

14 Investopedia: “Avoid Capital Gains Tax on Your Investment Property Sale”

15 Fidelity: “How to invest tax-efficiently”

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