President Biden’s Budget Adopts One Of California’s Most Controversial Ideas

One of the big surprises included in the Biden administration’s first budget, released the Friday before Memorial Day weekend, was the confirmation that President Joe Biden’s proposed capital gains tax hike would apply retroactively to gains realized prior to any change in tax law. President Biden is calling for a near doubling of the federal capital gains tax rate from 23.8% to 43.4% for households with income in excess of $1 million, and his new budget stipulates that the near 100% rate increase would apply to gains realized starting in late April. 

All previous federal capital gains tax increases have become effective at the time of enactment, or the following calendar year. Many fiscal policy analysts and experts have highlighted the unprecedented nature of the capital gains tax hike that President Biden is asking congressional Democrats to pass. 

“Never been a retroactive cap gains tax increase in US history,” Dan Clifton, partner and head of policy research for Strategas Research Partners, tweeted on May 27. “Does not mean it wont be this time. But there is a reason not to do that. Leads to asset allocation distortions. 1969, 1976, and 2012 were date of enactment. 1986 was prospective.” 

Republicans on Capitol Hill who were already opposed to a capital gains tax hike are especially critical of the retroactive nature of the tax increase proposed by the White House. 

“I just think retroac­tive tax pol­icy is ter­ri­ble pol­icy,” Sen. John Thune (R-S.D.) told the Wall Street Journal. “Peo­ple have made plans and re­lied on cur­rent law and cur­rent pol­icy and you can’t change the rules in the mid­dle of the game.”

Financial services industry leaders have also come out in opposition to a retroactive capital gains tax hike. David Solomon, chief ex­ec­u­tive of Gold­man Sachs Group Inc.

GS
, said in April testimony to lawmakers on Capitol Hill that levying a tax increase retroactively “creates ex­tra anxi­ety and ex­tra un­certainty, and that would just slow down eco­nomic ac­tivity.” Solomon added that “retroactivity is some­thing to be very, very cau­tious about. And I do think a chilling of investment activity through a higher capital-gains tax is something to also think through carefully.” 

Retroactive Tax Hikes: An Idea Imported From California 

While heretofore unseen at the federal level, a retroactive income tax hike, a large one at that, is not without precedent in the states. California’s Proposition 30, a 2012 state income tax hike championed by then Governor Jerry Brown and other leading Golden State Democrats, was also retroactive. 

That income tax hike, which was approved by more than 55% of California voters, applied to both wage and investment income. Proposition 30 imposed three additional upper income tax rates, resulting in the 13.3% top rate on the books in California today, which is the nation’s highest top marginal income tax rate. That income tax hike, which applies to both wage and investment income, was approved in November of 2012 but applied to income earned and gains realized going back more than 10 months, to the first day of 2012. 

The retroactive nature of Proposition 30 triggered balloon tax payments for some California taxpayers. As the official ballot summary for Proposition 30 warned, because the tax increase was made effective more than 10 months prior to its enactment, “affected taxpayers likely would have to make larger payments in the coming months to account for the full-year effect of the rate increase.”

So many people and businesses have moved out of California since 2010 that the state will lose a congressional seat for the first time ever next year. There are many factors that contributed to the loss of population that has resulted in diminished congressional clout for California, to be sure. But California politicians and voters really set the tone for the past decade by kicking it off with a massive tax hike that made it clear for all that, even after paying the nation’s highest income tax rate, the rules of the game could be changed after the fact to raise that rate even further, by nearly a third in the case of Proposition 30. 

The tax hikes imposed by Proposition 30 were scheduled to expire in 2019. California voters, however, extended the Proposition 30 income tax hikes for another 12 years by approving Proposition 55 in 2016. Proposition 55 passed with greater support than Proposition 30, with more than 63% of California voters approving Proposition 55, compared to the 55% of support with which Proposition 30 was approved four years prior. California legislators pushed another retroactive income tax hike as recently as the 2020 session, but were unable to get the bill to Governor Gavin Newsom’s desk. 

President Biden wants to take the federal capital gains tax rate up to 43.4%, but that’s just Washington’s cut. In California, New York, and a number of other states, the combined federal and state capital gains tax rate would exceed 50% if Present Biden’s capital gains tax hike were to be adopted. 

“No one should ever be taxed twice on the same in­come,” Congressman Jerry Nadler (D-N.Y.) tweeted on April 14. “It’s not fair and it’s not just.”

Representative Nadler was referring to the state and local federal income tax deduction and his desire for it to be uncapped. But, as many have pointed out, Nadler’s quip could be more accurately applied to levies like the capital gains tax, which is truly a form of double taxation. President Biden is now asking congressional Democrats to nearly double the top rate at which this form of double taxation is assessed and to apply it retroactively, harming taxpayers who had been abiding by the laws as they were written at the time. To recycle Nadler’s comment, the retroactive, near 100% capital gains tax hike the White House is pushing is not fair and it’s not just, as many see it.