Higher personal taxation under a Biden administration could strengthen the case for municipal bonds and tax-managed equity strategies.

“A tax loophole is something that benefits the other guy,” A former U.S. Senator once quipped. “If it benefits you, it is tax reform.” Albert Einstein himself is reported to have said that, “The hardest thing in the world to understand is the income tax.” For as long as taxes have been assessed, taxpayers have looked for arbitrage opportunities to protect their net wealth, and the search for such opportunities has only increased as tax codes have grown in scope and complexity.

Joe Biden’s victory in the U.S. Presidential election, and recent confirmation that the Democrats will also control both houses of Congress, has potential implications for personal taxes. In this article, we briefly review his proposals and explain why we think they strengthen the case for municipal bonds and tax-managed equity strategies.

With Biden in the White House and the Democrats in narrow control of Congress, we believe higher and more far-reaching personal taxes are likely, as our summary below indicates. The biggest impact may be felt by those with income between $400,000 and $1m, particularly if they face a high cost of living. As the summary below indicates, they could see higher income tax and additional social security tax add a full 15 percentage points to their marginal rate.

But this is about more than who is in the White House. At the state level, we’re also seeing legislation aimed at increasing tax revenue. A few notable proposals include an increase in the highest marginal tax rates in New York, a “millionaires’ tax” in California and a 2% increase in taxes on individuals with over $1,000,000 in net income, which is already in place in New Jersey.

With the Democrats now in narrow control of the Senate, Rep. Ron Wyden (D-OR) may become Senate Finance Chair, where he has big ideas for change. Specifically, he has proposed an annual tax on assets, at the same rate as marginal income tax, that would be assessed on mark-to-market valuation rather than on realized gains or losses at the point of sale—creating a new tax liability on unrealized gains, but also new potential for tax deductions based on unrealized losses.

A brief summary of Joe Biden’s proposals for personal taxation

  1. Restore personal income tax rates above $400,000 of income
    • Top earners will see federal taxes increase from 37% to 39.6%.
    • In addition, the Net Investment Income (NII) rate of 3.8%, which will remain the same, would bring the total combined federal rate to 43.4%
  2. Increase capital gain rates for individuals earning over $1,000,000
    • Long-term capital gains and qualified dividend income for high earners will be taxed at the 39.6% (in addition to NII of 3.8%)
    • Under current law, long-term capital gains are taxed at 20% and short-term at the highest marginal rate of 37% (in addition to NII of 3.8%)
  3. Eliminate the step-up in cost basis at death for assessment of capital gains
    • Under Biden’s proposal, there would be a tax on unrealized asset appreciation at death
    • The current law states that assets can have their cost basis for tax assessment “stepped up” to current fair market value—effectively eliminating federal taxes on the sale of inherited assets
  4. Implement a 28% cap on itemized deductions
    • Biden’s proposal aims to limit itemized deduction at 28% and reinstate the “Pease limitation” on individuals earning more than $400,000—which reduces a taxpayer’s itemized deductions by 3% of adjusted gross income above a certain threshold
    • A quick and easy way to get a feel for this deduction is by reviewing an individual’s tax rate: a $1 deduction reduces tax liability by 39.6%, for an individual in the highest tax bracket
  5. Increase Social Security taxes on individuals earning over $400,000
    • Apply a 12.4% social security payroll tax on earners above $400,000

Source: The Tax Foundation, as of October 22, 2020.

What does all this mean for investment portfolios? The details remain undefined, but we think the headlines are clear enough for two immediate takeaways, one for fixed income portfolios and one for equities.

Higher Taxes Make Municipal Bonds More Attractive

If enacted, the Biden proposal to lift the top tax bracket for individuals is likely to increase demand for municipal bonds. Sheltering income from Federal, State, and in some instances local taxes should only increase the appeal of municipal bonds as tax rates moves higher to close budget gaps, and most states do not tax income from municipal bonds issued in an investor’s state of residency. In addition, should Biden succeed in increasing the corporate tax rate to 28%, it could further increase demand for municipal bonds from banks and some insurance companies.

Higher Taxes Strengthen the Case for Tax-Managed Equity Strategies

The proposals with the largest potential impact on equity portfolios would be those for higher marginal taxes and for long-term capital gains to be taxed at the marginal rate. That impact can be meaningful, which is why we think the prospect of higher personal taxes strengthens the case for using tax-efficient portfolio management strategies to enhance after-tax investment returns.

During the lifetime of a portfolio, the two most important aspects of tax management are tax loss harvesting (realizing a loss by selling a security, which can then offset a taxable gain from another security) and tax deferral (delaying taxation so that money remains invested and continues to generate returns). These tax management strategies can generate a difference between excess after-tax return and excess pre-tax return, relative to a benchmark: we call that difference “tax alpha.”

In a recent paper, we used Monte Carlo simulations to offer a sense of the level of tax alpha that a naïve tax loss harvesting strategy could generate, through different 10-year stock-market return and volatility scenarios, given the current federal tax regime.

We started with an equally weighted portfolio of 500 stocks. We assumed three different market return levels (0%, 6% and 10% annualized) and two stock volatility levels (25% and 35% annualized), and correlation between stocks of 0.3, which is similar to the level observed historically between constituents of the S&P 500 Index. The threshold for tax loss harvesting was a loss of -5% over the course of a month, in which case the stock was sold and, to avoid “wash sales,” a stock with very similar risk-factor characteristics was immediately purchased to replace it.1

Our headline finding was that tax alpha was highest when market return was lower and stock volatility was higher. For example, the average annualized tax alpha from our 1,000 simulations, when the market return was 6% and stock volatility was 25%, was 1.0%; when the return was set at 0% and stock volatility was 35%, average tax alpha was 2.4%.

So what happens to our simulated tax alpha findings when we plug in the Biden tax proposals instead of the current regime? The results are shown in figure 1, and they are not surprising.

Figure 1. The Biden Tax Proposals Could Increase the Availability of “Tax Alpha”

Average tax alpha from 1,000 Monte Carlo simulations for each market-return and stock-volatility scenario, and for the current and Biden-proposed federal tax regime

The Biden Tax Proposals Could Increase the Availability of “Tax Alpha”

Source: Neuberger Berman. See the main text for the methodology, assumptions and our definition of tax alpha, and for further detail see Ram Ramaswamy and David Waugh, “Tax Alpha: Managing Equity Portfolios for Tax Efficiency” (August 2020) at https://www.nb.com/transfer?URL=insights/tax-alpha-managing-equity-portfolios-for-tax-efficiency 

In our updated analysis, average tax alpha increased under President-elect Biden’s tax proposal across all six of our return and volatility scenarios, by between 20% to 30%. As we would expect, tax alpha tends to be more pronounced in simulated environments with lower returns and higher volatility—and, when pronounced, tax alpha also tends to lead to higher taxes. The higher taxes are, the more scope there is to save money by offsetting taxes with portfolio losses.


When considering the implications of changing tax codes for your portfolio, it’s important to take a holistic perspective and to seek qualified tax counsel. Among the many things to consider, alongside the potential to realize long-term capital gains before new tax legislation comes into force or donating in-kind securities to charity at the point when tax laws change, are the potential tax benefits of the municipal bond market and the potential advantages of tax-managed equity strategies.