Janet Yellen's proposal for a capital gains tax in US may push global money towards markets like India

• US Treasury Secretary Janet Yellen has proposed a hike in capital gains tax, as well as taxing unrealised capital gains.
  
• Wealth managers believe this could spook investors in the US and that could move money towards emerging economies, which includes markets like India.
  
• In the last six months, foreign institutional investors have ploughed nearly $20 billion in the Indian market.
  

Janet Yellen, the Treasury Secretary in the Joe Biden administration, has proposed taxing unrealised capital gains. At a time when there are fears of a bubble in emerging markets like India, this move in the US could come as a big boost if spooked investors on Wall Street decide to move money to other destinations.

In a virtual conference hosted by The New York Times, Yellen discussed ways to fund the Biden administration's long-term economic reconstruction programme -- such as a hike in capital gains tax as well as taxing unrealised profits.

Simply put: What is capital gains tax?

Capital gains tax is a tax on the profit that investors realise on the sale of their assets. If you sell shares that you own in a company and make a profit when you sell them, you pay a tax on the profit. The current rate in the US is up to 37%, based on the asset type, period of holding, and the income of the investor.

What Yellen, the former Chair of the US Federal Reserve, has proposed is that tax and much more. She wants investors to pay a tax on the increase in value of stock every year, even if it is not sold. So if a stock goes from $100 to $150 a piece in a year but you haven’t sold it. You may still have to pay a tax on that $50 a share, where you haven’t made a profit yet. That’s tax on unrealised capital gains.

Here’s what big fund managers have to say about Yellen’s proposal

Wealth managers believe this could spook investor sentiment, pushing them away from the US and towards emerging markets like India.

Billionaire investor Howard Marks said, “I think that would hit sentiment. It would obviously make it less attractive to be an investor, all things being equal.”Marks is the chairman of Oaktree Capital which has nearly $140 billion worth assets under management.

Marks isn’t alone. He is joined by Peter Mallouk, the chief executive officer of Creative Planning which manages assets worth nearly $70 billion. “Creative Planning clients are holding 20% to 40% of their portfolios in foreign stocks, both emerging markets and developed markets, tilting toward the latter,” he said in a podcast with ThinkAdvisor.

Nilesh Shah, one of India’s biggest money managers and the managing director of Kotak Mahindra Asset Management Company, told Business Insider, “Other things being equal, levying capital gains tax in the US will enhance fund flow to emerging markets.”

India has already seen a big inflow of global capital

Since January 2020, even after accounting for the COVID-19 shock, foreign institutional investors ploughed in nearly $10 billion in India. Over the last six months, this figure jumped to nearly $20 billion.

India was the best performer amongst the world's 10 major equity markets in the last 6 months and one of the big reasons is the dramatic spurt in foreign investment.

The flow of global capital to emerging markets is significant because there are already fears of a bubble. “In fact, over the past two weeks, weak balance sheet stocks have outperformed those with strong balance sheets—a sign that the equity market is not yet worried about risks that could jeopardize corporate funding requirements,” Goldman Sachs reportedly said.

If there is a fresh inflow of dollars due to Yellen’s move, it will make the emerging-market bubble (if at all) bigger and delay the bust that many expect.


However, Shah says there is more to investment allocations than just tax policies. “Tax is a small component while deciding allocation for investments. At the end of the day, our growth, governance and return potential will determine flows from investors,” he explained.

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