President Joe Biden’s American Family Plan will likely include a large increase in the top federal tax rate on long-term capital gains and qualified dividends, from 23.8 percent today to 39.6 percent for higher earners. When including the net investment income tax, the top federal rate on capital gains would be 43.4 percent. Rates would be even higher in many U.S. states due to state and local capital gains taxes, leading to a combined average rate of 48 percent compared to about 29 percent under current law.
A high combined capital gains tax rate would influence when taxpayers decide to sell assets and realize the gain. If the effect is large enough, federal revenue from capital gains income would decline because taxpayers have decided to avoid realizing gains and the higher tax rate.
Most states levy their individual income tax rates on long-term capital gains and qualified dividends, though Hawaii levies lower tax rates. Nine states provide general exclusions or deductions for long-term capital gains. The average top tax rate on capital gains at the state level is about 5.2 percent, for a combined average rate of 29 percent under current law. If the top federal capital gains rate rises to 43.4 percent, this would raise the combined tax rate on long-term capital gains to 48.4 percent.
Thirteen states and the District of Columbia would have a top combined capital gains tax rate north of 50 percent. California, New York, and New Jersey would have combined rates of more than 54 percent. Top combined rates in some localities would go even higher. For example, New York City levies a local capital gains rate of 3.876 percent, which means an investor would pay an all-in rate of nearly 58.2 percent. Residents of Portland, Oregon would face a top capital gains rate of 57.3 percent.
Using the Tax Foundation General Equilibrium Model, we find that raising the top capital gains tax rate to 39.6 percent for those earning over $1 million would reduce long-run GDP by about 0.1 percent and reduce federal revenue by about $124 billion over 10 years.
Economic and Revenue Impact of Raising the Top Capital Gains Rate to 39.6 Percent for Those Earning over $1 Million
Source: Tax Foundation General Equilibrium Model, March 2021.
Under Biden’s proposal for capital gains, the U.S. economy would be smaller, American incomes would be reduced, and federal revenue would also drop due to fewer capital gains realizations. Other proposals, such as partially repealing step-up in basis for capital gains, may help offset the realization effect and increase federal revenue, but it remains important to consider the combined tax rate on capital gains in the context of the President’s tax proposals.
Top Marginal Capital Gains Tax Rates Under Current Law and Biden Capital Gains Tax Proposal
Top Capital Gains Rate (Current Law)
Top Capital Gains Rate (Proposed)
Alabama
28.8%
46.4%
Alaska
23.8%
43.4%
Arizona
29.8%
49.4%
Arkansas
26.8%
46.4%
California
37.1%
56.7%
Colorado
28.4%
48.0%
Connecticut
30.8%
50.4%
D.C.
32.8%
52.4%
Delaware
30.4%
50.0%
Florida
23.8%
43.4%
Georgia
29.6%
49.2%
Hawaii
31.1%
50.7%
Idaho
30.7%
50.3%
Illinois
28.8%
48.4%
Indiana
27.0%
46.6%
Iowa
32.3%
48.6%
Kansas
29.5%
49.1%
Kentucky
28.8%
48.4%
Louisiana
29.8%
47.0%
Maine
31.0%
50.6%
Maryland
29.6%
49.2%
Massachusetts
28.8%
48.4%
Michigan
28.1%
47.7%
Minnesota
33.7%
53.3%
Mississippi
28.8%
48.4%
Missouri
29.2%
48.8%
Montana
30.6%
50.2%
Nebraska
30.6%
50.2%
Nevada
23.8%
43.4%
New Hampshire
28.8%
48.4%
New Jersey
34.6%
54.2%
New Mexico
27.3%
46.9%
New York
34.7%
54.3%
North Carolina
29.1%
48.7%
North Dakota
25.5%
45.1%
Ohio
28.6%
48.2%
Oklahoma
28.8%
48.4%
Oregon
33.7%
53.3%
Pennsylvania
26.9%
46.5%
Rhode Island
29.8%
49.4%
South Carolina
27.7%
47.3%
South Dakota
23.8%
43.4%
Tennessee
23.8%
43.4%
Texas
23.8%
43.4%
Utah
28.8%
48.4%
Vermont
32.6%
52.2%
Virginia
29.6%
49.2%
Washington
23.8%
43.4%
West Virginia
30.3%
49.9%
Wisconsin
29.2%
48.8%
Wyoming
23.8%
43.4%
Average (unweighted)
29.0%
48.4%
Source: Tax Foundation calculations, state statutes.
Errata: This piece has been updated to include the effect of state tax exclusions and deductions for capital gains.
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