What Might a Capital Gains Tax Increase Mean for the Stock Market?

There have been only three notable increases in the capital gains tax rate over the last 51 years (there were numerous minor/incremental instances). That makes President-elect Biden’s position on raising the capital gains tax noteworthy and a relative rarity should it actually occur. The rate increases mentioned above took effect January 1 of 1970, 1987, and 2013. Nothing particularly unusually negative happened in the S&P 500 trend in the six months leading up to these dates. This suggests that the prospect of a change in the tax rate did not cause any notable distortion to the prevailing market trend(s).

The following is how the S&P 500 performed in the year following the January 1 tax increase:

• 1970 saw an annual average change of -14.5% (12/12 rate-of-change). Don’t read too much into this since the economy was shifting into a recession that was forecasted by ITR Economics before the prospect of a tax increase became a reality.
• 1987 saw an annual average change of +19.7% (12/12). The market peaked in August, fell 30.2% to a November low, and was recovering by December. The year as a whole was still positive. ITR warned clients the month before the fall to go to cash because of technical factors involving the economy and the S&P 500.
• 2013 saw an annual average change of +19.2% (12/12). No unusual negativity occurred during that year.
  
  ITR Economics thinks that the discussion regarding how to prepare for a potential capital gains tax increase at the individual level is something best done with a qualified, trusted wealth advisor in association with a tax advisor. We can’t possibly know the particulars of each situation, and we offer no counsel as to course of action.

If the objective of raising the capital gains tax is to fatten government coffers, the evidence shows that raising the capital gains tax rate has no statistically significant effect on the size of federal tax receipts stemming from capital gains. Additionally, realized capital gains may be depressed until such time as the capital gains tax is lowered in the future; investors may wait out the tax increase because the pendulum is bound to swing the other way.

Not many people who have capital gains want to see a tax increase. We also aren’t used to having to think about such a potential. Putting the emotions involved aside, our analysis shows that the government’s efforts are unlikely to succeed if the goal is to raise more money to spend elsewhere, and savvy investors know to wait it out. The market is not likely to tank, and we can afford to wait this change out. Breathe. The market, and you, will be okay.

Brian Beaulieu
CEO