The American Families Plan: A Negative for Entrepreneurship and Capital Formation

By SBE Council at 29 April, 2021, 11:11 pm

by RAYMOND J. KEATING-

In his speech to the nation, President Joe Biden unveiled his very big spending plans and tax increases that he is billing as an 'American Families Plan.' Given that the proposal would undermine entrepreneurial efforts to startup, build and expand businesses, and therefore, restrain economic, income and job growth, it would be actually hurt families, their small businesses and the small firms employees work for.

The plan focuses on increased spending in key areas, accompanied by tax increases centered on upper-income earners, including raising the top individual income tax rate from 37 percent to 39.6 percent.

Another major tax increase would raise the individual capital gains tax rate from 20 percent to 39.6 percent - in effect, doubling the tax rate - on those earning more than $1 million. (In a previous blog post, we also noted the harm that President Biden's corporate tax hike proposal in his infrastructure package would impose on small businesses, their workers and families, which can be read here.)

Capital Gains Tax Undermines Investment and Entrepreneurship

Given that the capital gains tax is a direct levy on the returns on entrepreneurship - for both entrepreneurs and those who invest in entrepreneurial ventures - and entrepreneurship is central to economic, income and employment growth, capital gains taxes rank among government's most economically destructive levies.

Starting up, building and investing in businesses are endeavors fraught with risk and uncertainty. By reducing potential returns, higher capital gains taxes serve as a clear disincentive for such critical economic activity.

Back to the 70s

If the Biden capital gains tax increase were implemented, it would bring about the highest capital gains tax rate since the late 1970s.

For good measure, it must be kept in mind that the ObamaCare 3.8 percent tax brings the current capital gains tax up from 20 percent to 23.8 percent, and would result in a top Biden capital gains tax rate of 43.4 percent.

In turn, the total capital gains tax rate would top 50 percent in various states when including the state tax rate.

The Inflation Factor

And then there's inflation. Since capital gains are not adjusted for inflation, the real capital gains tax rate is pushed even higher.

Therefore, for an investment returning 10 percent per year for three years, for example, a combined federal and state capital gains tax rate of 50 percent jumps to approximately 64 percent in real terms with inflation running at 2 percent per year, and to about 87 percent with inflation running at 4 percent per year.

The discouragement to investing in entrepreneurial ventures with high risk and uncertainty is unmistakable, and a clear negative for the entire economy.

Entrepreneurs Need Capital and the Resources of Investors

In reality, taxes on upper-income earners do not exclusively affect those being particularly targeted. Rather, the increased costs and altered incentives, again, have clear negatives in terms of lost economic, income and employment growth. That is, tax the wealthy, and the negatives ripple throughout the economy - especially given that the wealthy have the resources needed for investments in new and expanding businesses.

That's certainly not pro-American family.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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