Capital Gains Taxes: A $0.9 Billion Increase on Private Equity

October 22, 2012

Capital gains taxes are set to rise come January 1st, with the capital gains tax rate rising from anywhere between 9 percent if you’re in the current 33 percent  bracket to 50 percent if you’re in the lowest bracket.  The capital gains tax rate is set to increase by 13 percent if you’re in the top tax bracket.  Because private equity professionals and investors in general already pay a good portion of their income in capital gains taxes, any tax rate increases could lower their anticipated lifetime income by a good amount.

On long-term capital gains taxes, tax rates are set to rise by much more, with the rate set to increase by as much as 100 percent for lower income individuals and 33 percent for higher income individuals.

If left unchanged, current statute is also set to reinstate the 5 year capital gains tax rate at 8 percent for individuals in the 10 percent and 15 percent brackets to 18 percent for individuals in the higher income level brackets.

How much would the federal government extract from the public as a whole and the private equity industry in particular if tax rates are allowed to rise in the first year?

Well, at best estimate, around $80 billion in net capital gains will be shifted into 2012 due to investors’ desire to sell at a lower rate.  At $80 billion in net realized gains, the federal government takes about $12 billion in taxes.  This is shown in the chart below by the blue bar in the bottom graph, which is the difference between the pink and green line graphs in the top graph.

Second, beyond the initial year of tax increase avoidance, what kind of ongoing impact might potential capital gains tax rate increases have on the federal government’s balance sheet?

It’s shown in the chart above by the orange lines for 2013 through 2015.  Overall, if tax rates rise, investors realize about $50 billion less a year in net capital gains, or about $8 billion lower than what would have happened.

Overall, the federal government still gets more taxes from individuals for the first few years because the remaining capital gains are taxed at a higher rate, but, it eventually turns into a losing proposition for both the taxpayer and the government.

How much can more in taxes may be levied on the private equity industry?  Best guess: an additional $900 million in taxes for just employees of private equity firms.

In all, should tax rates be allowed to rise come January 1, 2013, individuals can expect about a $12 billion tax increase initially from just the capital gains portion, of which perhaps $0.9 billion is levied on private equity professionals.  The tax increase would improve the federal government’s balance sheet in the initial years, after which it’s a losing proposition for everyone.

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