Presidential hopeful Hillary Clinton once said she wouldn't hike capital gains tax rates beyond the 20% top rate that existed during Bill Clinton's tenure, but recently she indicated that she could embrace a sliding scale of capital gains taxes that hits short term investors hardest. If Hillary Clinton's capital gains tax plans become reality, it could make Fool-worthy long term investing even more attractive.
Historical capital gains tax rates
When first introduced in 1913, the percentage of an investor's profit that was forked over to the IRS was tied to ordinary income tax rates. However, between 1934 and 1941 the capital gains tax scheme consisted of a sliding scale allowing investors to exclude a percentage of their capital gains based on how long they owned assets. As a result, taxpayers could exclude an increasingly larger percentage of their gains depending on how long they owned the asset. The thresholds that determined how much could be excluded were based on holding periods of one, two, five, and 10 years.
After 1941, a variety of capital gains tax rate schemes tied primarily to a person's income or the time period an asset is held have been implemented, leading to maximum capital tax rates that have fluctuated widely over time.
Today, short-term capital gains on investments held less than one year are taxed at an investor's ordinary income tax rate, while capital gain taxes on investments held longer than one year are taxed based on a sliding scale linked to investors' income tax bracket. People in the 15% or lower income tax bracket can be exempt from paying capital gains tax while the highest income earners in the 39.6% income tax bracket pay capital gains taxes of 20%, plus another 3.8% Medicare surcharge tax.
Clinton's capital gains tax plan
Before getting into the nitty-gritty of Clinton's plan, investors should remember that candidates often float plans on the campaign trail that never see the light of day. Also, since primaries haven't even been held yet, assuming any candidates' plans will become law is a cart-before-horses exercise.
Having said that, Clinton's plan, which isn't fully flushed out, would keep short-term capital gains rates based on ordinary income tax rates while also creating long-term capital gains thresholds for assets held longer than one year. It's unclear whether or not the sliding scale of capital gains taxes associated with income tax brackets will remain in place, but Clinton's plan -- all other things being equal -- could mean that capital gains taxes on assets held between one year and -- let's say -- three years, are taxed at a higher rate than assets held longer than three years. Further, it could mean that assets held for periods as long as 10 years could enjoy the lowest capital gains tax rates. Although Clinton hasn't disclosed what specific holding periods she'd support, its possible that she'll use time periods that are similar to those used between 1934-1941. If Clinton's plan comes to fruition, it would add even more incentive for investors to buy and hold.
What should investors do?
It's been proven time and time again that long-term investing creates more wealth than short-term trading, and tax policies that reward longer-term holding periods would seem to strengthen the argument against trading the market's inevitable annual ups and downs.
For that reason, most Foolish investors will likely be best served by doing nothing beyond sticking to their long-term investment plan. Such a plan should continue to include investing regularly and consistently in top shelf companies that can be socked away forever -- an approach that is a cornerstone of successful investors like Warren Buffett. Buffett, who is the world's richest investor, has made his billions by buying great companies like Coca-Cola and Wells Fargo and sticking with them through thick and thin, rather than churning his portfolio because of ever-changing tax policies.
Admittedly, Clinton's plans to change capital gains taxes could have unintended consequences, but despite fluctuating capital gains tax rates in the past, long-term investors have historically thrived regardless of tax rates and that could indicate that investors keeping an eye toward the future will continue to do better than those focusing on market whims and whispers.
Todd Campbell has no position in any stocks mentioned. Todd owns the equity research firm E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool recommends Coca-Cola. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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