China just announced a tranche of monetary moves to breathe air into its floundering economy, sending Chinese stocks soaring, But amid last week’s euphoria, a little-noticed bill was introduced in the U.S. Congress that has the potential to chill American investors’ appetite for Chinese assets.
The Patriotic Investment Act (PIA) – jointly introduced by House China Committee Chairman John Moolenaar and Senator Marco Rubio – proposes to add a new tool to the United States’ growing economic statecraft arsenal: using the tax code to explicitly incentivize U.S. money away from China. Specifically, the bill is the fulfillment of a recommendation from the China Committee’s bipartisan economic competition report to “[e]nact legislation to ensure capital gains and dividends made from investing in the PRC are not taxed at a lower rate than American workers’ salaries.”
Americans in the highest tax bracket pay 20 percent (with a 3.8 percent surtax) in taxes on most long-term capital gains, but 37 percent on their salaries. Because investment drives productivity and economic growth, the United States incentivizes investment through the tax code. But as Rubio put it, “The capital gains tax rate was meant to encourage investment in American innovation, not fund an oppressive communist regime.” To quote Moolenaar, “Our nation’s tax code should be incentivizing investment in the United States, not collaboration with the CCP.”
Thus, the PIA encourages “divestment from Chinese securities by removing the beneficial capital gains tax rate,” according to a bill summary – requiring all U.S. investors to pay the 37 percent rate for ordinary income on all future financial gains from investments in Chinese financial assets. The bill would allow investors six months to divest from China to avoid the higher taxes. The PIA would also increase the tax rate on future gains, deterring U.S. capital from returning to China and would deny foreign tax credits paid to China.
If U.S. investors want to use their capital to strengthen an adversary’s economic, technological, and military development, Washington should at least not subsidize this investment through the tax code.
Investors interested in the China market (despite the PRC’s economic woes and adversarial relationship with the U.S.) would do well to take note. Whereas the Biden administration’s Executive Order restricting investment into China focused only on active investment and was limited to a few sectors, the PIA is much broader. It would encompass passive purchases of Alibaba stock on the NASDAQ, as well as venture capital into Chinese semiconductor stocks. It would reach the approximated $1 trillion of U.S. capital invested in China.
U.S. investors in China should be especially alert because the PIA faces a decent chance of passage. First, it is a bill to increase taxes being led by two prominent Republicans; Democratic support should be easy to pick up. Second, with a massive tax cliff coming next year, one of the few post-election certainties is that Congress will pass a large tax package, and they’ll be looking for politically palatable ways to raise revenue. The PIA is just such a bill. What member of Congress would not support taxing those investing in the United States’ foremost adversary at least the same tax rate applied to American workers’ salaries?
The PIA’s introduction comes at a crucial time. China’s economy is the most fragile it has been in decades, with bankruptcies across the manufacturing sector, structural cracks in its real estate market, and declining consumer spending. China is desperate for foreign capital, as their latest moves to juice its stock market emphasize. China needs to retain as much capital as it can while appealing to future investors to sustain growth. The PIA would thus significantly exacerbate China’s worries about its declining appeal as a home for foreign direct investment in the years ahead.
Free trade, free flow of capital, and trillions in foreign investment have not fulfilled the dreams of many to transform the Chinese Communist Party (CCP) into a peace-loving, capitalist, or democratic ruling class. Under Xi Jinping, China’s economy is becoming increasingly statist, its politics totalitarian, and its foreign policy militarist. In just the last few months, the CCP has given military support to Russia to aid its war in Ukraine, attacked ships and seized islands from a U.S. treaty ally in the South China Sea, sailed warships into Japanese waters, fired an ICBM into the Pacific for the first time in decades, and flown bombers off the Alaskan coast.
While the United States is able but unwilling to respond to these affronts with military action, starving China of the capital needed to fuel its economic growth – and military modernization – is a very appropriate way to send a message to Beijing. More importantly, it’s a great way to send a message to Wall Street: stop giving money to the United States’ adversaries.