Paul L. Caron

Sunday, May 6, 2012

Luskin: The Coming Taxmageddon Will Crush Stocks by at Least 30%

Wall Street Journal op-ed, The 2013 Fiscal Cliff Could Crush Stocks, by Donald Luskin (Chief Investment Officer, Trend Macrolytic):

[U]nless current law is amended before year-end, the stock market has to fall by at least 30%.

It's all about how dividends are taxed -- and the reality that we are facing the biggest single hike in dividend tax rates in history. ... After year-end, under current law, the top dividend tax rate will rise to 43.4% from 15%. That's not only because the temporary low 15% rate granted under the 2001 Bush tax cuts will revert to the prior rate of 39.6%. In addition, a provision of ObamaCare slaps a 3.8% surtax on all forms of investment income, including dividends -- the resulting total is 43.4%. ... To be sure, we can quibble about the exact amount -- but not the direction. It's pretty much axiomatic: after-tax yields lower, stock prices lower.

All the same logic would apply to the increase in capital gains tax rates scheduled for year-end. With the expiration of the Bush tax cuts and the advent of the ObamaCare surcharge, the top capital gains rate will rise to 23.8% from 15%. The arithmetic for how much stocks will drop as a result is more complicated, because capital gains taxes are only paid when assets are eventually sold. But the effect on stock prices is the same -- it's down.

The same logic also applies here to bonds, because at year-end the top tax rate on interest income will rise to 43.4% from 35%. According to our simple arithmetic, if the yield on a 10-year Treasury is 2% today, it would rise to 2.3% with next year's tax rates. ...

So just by the numbers, the fiscal cliff matters. Investors are wrong to blithely assume that the boys in Washington will somehow do the right thing and it will all work out in the end. ... If there's a bargaining failure and the scheduled tax hikes on dividends aren't stopped, we'll be sorry we're spending so much political energy now debating about the "1%" and their supposed privileges. It's the 30% down in the stock market we ought be worrying about.

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Yes, the Dems 1st brought up changing the deferral rules a couple of weeks before the 2008 election. It's been floated a few times since, recently in the past few weeks.

Posted by: Sandy P. | May 7, 2012 9:13:30 AM

Another "Murdoch puppet" spouting off opinions (good reason to cancel WSJ subscriptions). In fact when tax rates increase, the stock market also rose-during the "Clinton administration". "Smart money" seeks shelter in DB plans and 401k plans, "Dumb money" pays the tax and it is re-circulated back to the masses. The real problem is a question that will be addressed in the upcoming election. Should the masses be able to eat with the classes? Once you have a large asset base a/k/a top 1%, you really do not want higher taxes or change-hence (conservative). If you do not have a large asset base, why not have change (bottom 99%). Another problem is the masses are easily duped and will vote for the policies of the top 1%. The top 1% generally have the top 1% in intelligence working for them. They know how to manipulate the media. They know how to manipulate the thoughts, hearts and minds of the 99%. The 99% have the "bottom 99%" of intelligence and economic clout. Unfortunately, they are easily out gunned in this battle.
Result-the top 1% owns 40%-of financial assets-the bottom 40% own 1%-funny isn't it.

Posted by: Nick Paleveda MBA J.D LL.M | May 7, 2012 7:47:02 AM

While the general conclusion (taxes go up, stock prices go down) makes sense, I wonder if the analysis isn't too simplistic. First and foremost -- what % of stock ownership is vested in entities that are unaffected by taxes: pension plans, 401(k), non-profit endowments, etc.?

Second, the effect of higher tax rates may be softened by decisions made by individual companies (i.e., stock buy-backs instead of dividends).

Third -- where would the capital supposedly to be pulled from the stock market going to go? Even if the after-tax return goes down, it does not automatically make competing alternatives a superior investment.

Posted by: Analysis, not politics | May 7, 2012 6:00:00 AM

Re Rich:
Except they weren't originally. The expiration was a compromise with the democracts, who didn't want them at all.

Posted by: Voyager | May 6, 2012 11:31:04 PM

"that there is no way that the Republicans can get a filibuster-proof majority in the Senate"

It is a budget matter not subject to filibusterer.

Posted by: Walter Sobchak | May 6, 2012 8:32:44 PM

Wait wait wait, is Donald Luskin telling me that the dividend tax rate on everyone that owns stocks will go from 15% to 43.4%? The same for cap gains from 15% to 23.4%? So Obama has proposed to revoke the tax deferral for 401K plans, IRAs, defined benefit plans, etc.? And has also proposed to withdraw from all bilateral income tax treaties that grant a lower withholding rate on dividends? And also proposed to hike the withholding tax on dividends from 30% to 43.4% for foreign investors not eligible for a reduced rate of withholding under a treaty? And also to tax capital gains sold by said pension funds and foreign investors at 23.4% instead of, you know, 0%?

Oh, wait, Obama hasn't? Huh.

Does everyone remember the instant 30% bump in the stock market when the Bush tax cuts on cap gains and dividends were implemented? What, you don't? Strange.

Posted by: Ugh | May 6, 2012 6:28:25 PM

>>is there any indication that the imposition of the higher tax rates would be a "bargaining failure" rather than deliberate administration policy?

Obama's stated policy (since before he was elected) was to reverse the Bush Tax cuts so the question effectively answers itself.

But more to the point, does it really matter whether Obama deliberately causes this to happen, or merely passively lets it happen? Either way it will happen on his watch, and he'll be responsible for it.

Posted by: looking closely | May 6, 2012 3:23:30 PM

There is no way these taxes will be cut. If Obama's re-elected, 2nd Term. It will suit his ideology with no risk.
If Romney wins, It will be George Mitchell, GHWB 2.
Bush the 1st raised taxes with Mitchell, then was left begging to lower them (remember the Luxury Tax?) 1st thing Bill Clinton did was (after Bush 1 was defeated) was abolish, with Repub votes, the Bush 1 tax increases.
Anyway the Rino's and Demo's have to fund the Govt. somehow.
I, as a stock trader, do not see any scenario, baring a huge Republican rout, that can stop these taxes from going into effect.

Posted by: Hubcap | May 6, 2012 3:03:12 PM

These Bush tax cuts were designed to expire in an election year, so that the Republicans can make a political issue out of it. A candidate that does not support extending the tax cuts will likely lose voters.
Clever move by the Republicans.

Posted by: Ron | May 6, 2012 2:48:19 PM

So..if Obama is re-elected and senate stays the same will the dumping begin immediately in November or wait till just before the rates kick in?

Posted by: Rich | May 6, 2012 2:12:32 PM

Taxation is theft. Other wise it wouldn't be done at the point of a gun.

Posted by: M. Simon | May 6, 2012 2:01:44 PM

If Obama is re-elected [and noting that there is no way that the Republicans can get a filibuster-proof majority in the Senate] is there any indication that the imposition of the higher tax rates would be a "bargaining failure" rather than deliberate administration policy?

Posted by: Subotai Bahadur | May 6, 2012 1:49:47 PM