Currently, long-term capital gains — the profits made by selling appreciated assets held for more than one year — are taxed at a maximum of 20 percent for higher-income individuals. 

Individuals with a taxable income of between $40,000 and $441,450 pay a more modest 15 percent tax rate on long-term capital gains, and those with an income below $40,000 owe no long-term capital gains tax at all.

Under current tax law, higher-income individuals may also owe an additional 3.8 percent net investment income tax on both long-term and short-term capital gains. As the law stands, income earned through the appreciation of a capital asset is almost always taxed at a lower rate than income earned through employment.

That might soon be changing, at least for certain higher earners. President Joe Biden recently unveiled a new policy that, if it becomes law, would hike the long-term capital gains tax for the highest earners to 43.4 percent (which would include the existing 3.8 percent capital gains surtax). In contrast, the current top marginal tax rate for wage income stands at 37 percent.

For most retail investors, this is hardly reason to panic. The new highest long-term capital gains rate would only apply to those making more than $1 million on an annual basis. Furthermore, tax experts are expecting there to be exemptions to the new highest capital gains rate for some taxpayers, including business owners.

Any major change in tax law calls for a reexamination of potential tax liability for high-earning organizations and individuals. Yet, more broadly, most economists are not expecting a major dent in equities markets if the higher capital gains rate becomes law. Following a one-day swoon in U.S. stocks when the planned capital gains tax increase was first announced, markets rebounded robustly the following day.

A report from UBS Global Wealth Management found that from a historical perspective, there is “no relationship” between the performance of the stock market and changes to the capital gains tax rate. UBS analysts expected equity market volatility based on an increase in the capital gains rate, to the extent there was any at all, to “be very short-lived.” LPL Financial broadly agreed with the conclusions of UBS, citing the state of the broader economy as being far more important to stock index performance in the past than were changes to the capital gains rate.

Additionally, although he had not previously announced plans for a specific top rate, President Biden has hardly been circumspect about his general intention to raise taxes on higher earners and on passive forms of income. Thus, many investors believe any effect of a higher capital gains rate has probably already been priced into the market. Others though, including some high-profile hedge fund managers, believe that the effect on stock market indexes has been minimal because President Biden’s proposed top rate of 43.4 percent does not have a realistic chance at becoming law.

Goldman Sachs economists predict that President Biden’s top 43.4 percent capital gains rate will never become law, and instead foresee a compromise top capital gains rate of 28 percent. Any increase in the capital gains rate would require the backing of all 50 Senate Democrats, because no Republican senator is expected to support any increase to the capital gains rate. An increase to the capital gains rate could be accomplished through reconciliation, meaning it would be immune to a Republican filibuster and would only require a simple Senate majority. Although Democrats could not lose a single Democratic senator in ushering in an increased capital gains rate, it is worth noting that a substantial majority of voters generally favor increasing taxes on the very wealthy, including a modest majority of even Republican voters.

It remains to be seen whether a top tax rate of 43.4 percent will become a reality for investors who make more than $1 million a year. But even a far more modest tax hike would be a significant change for top earners, and even the more optimistic fund managers accept the high probability of some kind of increase from today’s historically low capital gains rate making it into law.

Jonathan Wolf is a civil litigator and author of Your Debt-Free JD (affiliate link). He has taught legal writing, written for a wide variety of publications, and made it both his business and his pleasure to be financially and scientifically literate. Any views he expresses are probably pure gold, but are nonetheless solely his own and should not be attributed to any organization with which he is affiliated. He wouldn’t want to share the credit anyway. He can be reached at jon_wolf@hotmail.com.