Op-Ed: An Anti-Capital Capitol?
Democratic White House could spell disaster for investors.
Investors must be able to anticipate in order to be successful. Reacting only after an event officially happens is always too late. While stock prices have lately started adjusting to recession, renewed inflation, punishing fuel costs and the widening credit meltdown, another heavy shoe may well drop late this year from Washington D.C. This article is intended as a prediction of market risk depending on the presidential election outcome.
Like him or not on other issues, investors recognize that President Bush holds ready a sure veto on tax increases. Starting January 20, 2009, the ballgame could change radically. It seems unlikely that the present Congress will make permanent the dividend and capital-gains tax-rate reductions now in effect (they're set to expire after 2010). The more immediate risk for investors, however, is whether a new President and Congress will repeal them, effective as early as January 1, 2009.
This scenario is not my wild imagining: On March 13, the U.S. Senate voted on whether to repeal the favorable tax rates on capital gains and qualified dividends, and to raise bracket rates by 3% for present 25%-and-higher bracket taxpayers. (The latter would be strange policy in a recession or incipient recovery, but that's outside our main point here.). Of the two presidential hopefuls, only John McCain voted no - so one can easily see what might happen to the tax-veto pen after January 20.
Barack Obama stated publicly in late 2007 that he favors raising capital-gains rates to 28%. As President, with a House and Senate almost certain to be Democrat-controlled, he could swiftly "tax the rich" to balance the budget and pay for infrastructure and pro-poor social programs. According to those on the left end of the spectrum, stocks and dividends belong to "the rich." In actual fact, investors aren't all the rich - but they do include millions contributing to 401(k) and similar plans at work. Facts and logic don't always govern what happens in Washington.
Repealing today's favorable tax treatment of capital gains and qualified dividends would have a huge and time-concentrated negative impact on stock prices domestically and, to a lesser extent, internationally. Remember all the favorable media urging people to buy stocks back in 2003, when the then-new lower tax rates were first enacted? If the Senator from Illinois is elected President, we'll see a 180-degree reversal in 2008 and 2009. Newsletters, financial television, investor blogs, commission-driven brokers and print columnists will pound the reverse message home: "Sell now."
But it gets much worse: Dividends are a minor part of the issue. Raising capital-gains tax rates will create an immediate and even more massive incentive for millions of investors to sell stocks and mutual funds in which they have long-term gains before December 31, 2008. "Take your gains in '08, and your losses in '09" will be the mantra.
One seldom-discussed provision of the Bush tax cuts puts net long-term capital gains taxable in a zero percent (not a misprint) bracket for joint filers with 2008 taxable incomes under $65,100. Working the numbers backwards, that means couples with $83,000 of AGI or less - higher for those who itemize rather than take the standard deduction.
Investors with moderate to middle incomes, including many retired members of the middle class, would logically sell their stocks and funds before 2009 if the White House becomes Democratic. We're talking millions of households: Fund redemptions would force portfolio managers to liquidate stocks dollar for dollar. Nearly 81% of the net inflows into stock mutual funds between January 2004 and March 2008 went to overseas markets, so selling would happen around the globe. Hedge funds, known for riding momentum, would jump to the short side massively.
Investors have been exhorted to be tax efficient and to hold for the long term. This election scenario means that selling would, for a concentrated eight-week period, become the tax-efficient move of choice. If you hold, for example, 100 shares of Apple (AAPL) with a $10,000 long-term gain, you may be able to sell it at zero tax liability by December 31 - or pay $2,000 or more for selling later. As they say, you do the math. Even if you don't have large long-term gains to take, millions of others do - and their selling will drive your stocks and funds down.
But selling only after November 4's result is known will make you part of a stampede, so raising cash earlier is most logical. If this election scenario doesn't play out, selling in a zero-tax year has only one downside: If you love a fund or stock sold at a gain, you can buy back and will need a new 366 days to achieve long-term status again. Buying back after January 1 makes the most sense.
There are two glimmers of good news. If the higher-tax scenario plays out, real estate investment trusts (REITs), whose income distributions are already fully taxed as non-qualified dividends, would regain relative favor when put back on equal tax footing. Municipal bonds, lately doghouse bargains, would gain added holders if marginal tax rates on "the rich" rise.
As stated at the outset, preparation rather than reacting after the fact is key for investment profits.
You have been warned.
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