Market Reaction to Biden's Capital Gains Tax Plan Surprises Political Pundits

It is possible, Friedman opined, "that the administration leaked the proposed rate to test the market reaction. They then conceivably could mollify the markets by backing off to a lesser rate increase. More likely, though, Biden will maintain his position as a starting point for congressional negotiations."

A capital gains tax rate increase "is in the offing," Friedman said. "But I doubt it will go nearly so high. When the dust settles, we'll likely see a rate in the 25% to 28% range."

Both Valliere and Raymond James analysts agreed that Biden's tax proposals are an opening salvo in the negotiation process.

"It's entirely possible that the top capital gains rate for millionaires will rise from 23.8% now to something like 30%," Valliere said. "Most of the administration's proposals will get watered down later this year."

Raymond James analysts noted in their Friday email briefing that the administration's proposed hike in the capital gains rate "to the envisioned ordinary income rate of 39.6% on incomes above $1 million" as part of Biden's American Families Plan "is likely to see adjustment on the rate or the income threshold."

A higher capital gains rate "is a staple of Biden's 'economic fairness' agenda and has been well communicated over the course of his candidacy/presidency, but we expect the market reaction seen Thursday to raise hesitancy among moderate Democrats and serve as a potential moderating force," Raymond James analysts said.

"In an aggressive scenario of a 39.6% rate being effective in 2022," the analysts continued, "we would expect to see continued market volatility as the Biden infrastructure/tax agenda makes its way through Congress."

The markets, Valliere warned, will also have to be on guard for other tax trial balloons: "raising the estate tax, possibly combined with killing the 'step up' basis; hiking the top individual rate; almost certainly increasing the corporate rate; imposing a minimum corporate tax; and cracking down on business loopholes, including the sheltering of profits abroad."