[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.