On Friday, Democratic Presidential hopeful Hillary Clinton spelled out her new plan to raise tax rates on capital gains — the profits people reap when they sell an asset a like stock, parcel of real estate or even a business.
The capital gains tax rate has been a political football for years, not least because rich people tend to own — and sell — the most stuff. Here are a few key things you need know about capital gains tax in general, and Clinton’s proposal specifically.
How are capital gains currently taxed?
While the tax rate on capital gains has bounced around a lot over the years, the big tax deal reached in the last hours of 2012 pushed up the top rate on long-term capital gains to 20% — still far lower than the 39.6% top rate on income (although top earners also pay a health-care related 3.8% surtax on investment income). For taxpayers in lower brackets, long-term capital gains tax rates max out at 15% or less.
There is an exclusion for profits of up to $250,000 ($500,000 if you are married) on your primary residence, so many homeowners won’t have to worry about a huge tax bill when they move.
That’s all for long-term capital gains, by the way. Short-term capital gains — that is, the profit made on stocks or other assets held less than a year — get taxed at the same rate as income.
Why do capital gains get a tax break?
In the relatively recent past, both Democratic (Bill Clinton) and Republican (George W. Bush) presidents have cut the capital gains rate in hopes that doing so would spur the economy. Since the capital gains tax is really a tax on investment, economists hope that lowering the tax will prompt people to invest more of their money rather than spend it.
The idea is that if more people are looking to invest, it should be easier for start-ups or existing companies that want to develop new products to find funding.
That’s also why short-term gains get taxed as income — because short-term gains benefit people who make their living buying stuff and then quickly reselling, rather than investing for the long term.
So what’s the problem?
In addition to spurring investment, a low long-term capital gains rate also spurs inequality. It’s not hard to see who the biggest beneficiaries are: people who invest in the stock market or who sell businesses that they own.
The low capital gains rate is one reason America’s 400 biggest earners paid a tax rate of less than 17% in 2012, the latest year for which the IRS has released data. There are also questions about whether the low capital gains rate really does boost the economy.
After all, while the economy took off under Bill Clinton, the stock market has also continued to soar since the most recent increase in the long-term gains rate.
What is Hillary Clinton proposing instead?
Hillary Clinton’s proposal would require wealthy taxpayers to hold their investments much longer to get the full long-term capital gains tax benefit. Instead of a single long-term gains rate that kicks in after one year, her plan would create a series of rates ranging from 36% to 24% for those who hold investments for at least two years but less than six years.
Clinton says she isn’t doing this simply to raise taxes on the rich. Rather it’s to discourage short-termism among big investors. That’s something even many on Wall Street regard as a problem, even if higher taxes might not be their preferred solution. So it looks like good politics.
Is it a good idea?
That, of course, depends on who you ask. Many progressives would simply like to see capital gains taxed as income.
Yet it’s not even clear whether Clinton’s proposal could actually change investor behavior — even if it could pass Congress. “My general impression is deep skepticism,” Leonard Burman, director of the nonpartisan think tank the Tax Policy Center told Reuters earlier this week. “Frankly, I don’t see the logic in trying to encourage people to hold assets for longer than they want to.”