Updated: Sep 7, 2021
Picture credit to HedgeEye market insights.
Crypto markets are down following recent tax change speculation from the U.S. Government. Rumors of higher taxes on capital gains has investors worried about the future of growth and is causing panic selling in the equity and crypto markets. This is a speculative reaction to the uncertainty surrounding the proposed Biden tax plan.
The reality is that people often panic sell great investments during times of uncertainty. This selling allows new investors to come fill their place and grab that investment at a good price. It's the natural life cycle of an investment. Since the technology hasn't changed we can assume that the bullish trajectory of the market will continue in the next 3-5 years, making this a perfect buying opportunity.
In order to understand how this works, First, let's discuss some key language:
Ordinary Income Tax: This is the tax you pay on any earned income. (Money you earn from working a job). The current income tax rate is 15% for most Americans and as high as 37% for individuals making over $500K.
Capital Gains Tax (Cap. Gains): This is the tax you pay on investment earnings. You pay taxes on the excess earnings generated from the investment. It's important to understand that this tax is not triggered until you sell the investment.
Short Term Capital Gains Tax: The tax you pay on profits for investments held UNDER 1 year. The tax rate for S/T gains is the same as your ordinary income rate.
Long Term Capital Gains Tax: The tax you pay on profits for investments held OVER 1 year. The lowest cap gains rate today is 0% for individuals making under $40K and 20% on the high end.
Let's use this knowledge to understand the current issue:
Investors currently pay a 20% top rate on long-term capital gains. Under Biden’s proposal, the federal capital-gains tax rate would be as high as 43.4%, according to Bloomberg.
Under current law, long-term capital gains are taxed favorably with respect to wages. The wealthy pay a top 37% rate on wage income.The White House plan would instead tax capital gains as ordinary income, at a top proposed rate of 39.6%. It would apply to those with more than $1 million in annual income.
Investors who were planning on holding their investments for the long term will now have no reason to invest in the same way. Wealthy investors sold positions at the break of the news expecting to get out of their investments early rather than risk paying higher taxes in the future.
Why is this affecting the Crypto markets?
Rumors of the proposed tax plan being used for crypto holdings had many investors worried. Panic selling took place for the same reason as equities- you can either take your profits now and pay 20% capital gains tax or you can risk holding them and paying 40% in the future… It was an obvious choice for investors.
Was the market over-reacting?
The severity in which the markets fell was overly-reactive since the tax plan hasn’t even passed. The rumor of change caused markets to panic sell without any evidence of the tax plan passing. On the other hand it was a rational move to secure some part of the investment in case the plan actually pulls through.
Investors were right to consider pulling investments but panic selling is rarely ever the right answer to these situations.
Why Buy the Dip?
Whenever a market experiences a pullback or correction it always invites the skeptics out. All of the “I told you so” people have their 5 minutes of fame claiming they knew it would crash. The simplest question to ask yourself is that besides the ticker price, what changes? Has Bitcoin’s core technology changed? Has Ethereum's hash rate slowed down? Has XRP helped pass new crypto legislation?
The simple answer is… nothing has changed regarding the technology or infrastructure in the past week to justify people selling their coins.
The reality is that people often panic sell great investments during times of uncertainty. This selling allows new investors to come fill their place and grab that investment at a good price. It's the natural life cycle of markets. Since the technology hasn't changed we can assume the bullish trajectory of the market will continue for the next 3-5 years, making this a perfect buying opportunity.
But What about the Cap Gains tax on Crypto?
First it's important to note that crypto taxation is still being discussed and no official policy decisions have been made regarding crypto. The simplest answer is that even if someone has to pay an extra 17% in taxes they will still likely beat the returns from traditional investments. Crypto has over-performed most asset classes during times of economic uncertainty so as a hedge asset it still holds value.
Why Are We Raising Taxes?
The United States is in more debt than we know how to get ourselves out of. We owe money to other countries as well as to our own citizens. The current passing of a $2 Trillion infrastructure plan just added to the debt levels and is creating a panic amongst regulators to fund these projects.
There are 2 ways being argued as to how to get out of debt:
We grow our economy so that we can afford to pay back the debt.
We try and tax those who already accumulated wealth to help pay back the debt.
The idea to tax the wealthy is a smart political move because it feeds on the natural inclination for people to want to even the score. The reality is that these policies discourage the individuals who create jobs from taking risks. Long term investing is very important because it provides millions of Americans with an opportunity to retire. If money is taken out of long term investments and instead used for short term activities then it creates problems for the workers who just want to hold for retirement.
Incentivizing investors to think long term is crucial to the health of the economy. Lowering taxes typically allows companies to spend that money hiring more people, giving out bonuses, giving out raises, opening new factories/ branches, creating new job roles etc..
These new changes are directly going to impact individuals making over $500k per year. In the long term these policies will discourage investors from taking risk and will result in job loss, momentum loss, and opportunity loss for the rest of the economy. Short term political decisions are great for providing a band-aid solution but investors know better than to be short sighted. Markets are likely to remain uncertain until this issue is resolved.
The wealthy individuals who own investments have responded to the administration's actions but voting with their Dollars. The market very clearly understands that these tax policies are going to hurt the individuals who create growth. If the bill passes then we could see a significant shift in investing behavior for the next 3-4 years.
As money flows out of traditional investments and into tax advantage vehicles (trusts) we may see some inflows into crypto as investors look to diversify into the future.
Disclaimer: This article is the result of the analysis carried out by analysts associated with ChartAddicts. The article does not purport to represent the views or the official policy of ChartAddicts. This is not investment advice.
ChartAddicts Analysis Team