Wall Street analysts have advanced a variety of theories to explain what’s behind the recent decline in the stock market.
David Bianco, chief U.S. equity strategist at Deutsche Bank, poses the question in his latest research report: “Are April tax payments exacerbating the sell-off?”
A combination of recent changes to the tax code and last year’s outsized stock market gains have likely made investors’ tax bill substantially larger this year than in years past.
Bianco walks clients through the finer details (emphasis added):
The tax act of 2012 (ATRA) raised the tax rates only for the top bracket (incomes over $US400,000; $US450,000 for couples); still, many with income over $US200,000 ($250,000 for couples) are facing a substantial tax bill this April.
This is because: (1) additional medicare tax of 0.9% on wages and 3.8% on investment income for households with income over $US200,000 ($250,000 for couples) was applicable for the first time in 2013; (2) ATRA resumed the exemption phase-out and deductions limitation for income over $US250,000 ($300,000 for couples) after a three-year hiatus; and (3) ATRA raised the rate on qualified dividends and capital gains by 5% for the top tax bracket. It is unlikely that these taxes were fully paid during 2013.
We estimate an April tax bill of around $US35 billion higher than March from these three provisions. Based on 2011 detailed tax returns data, we estimate that if the above three provisions were applicable in 2011, it would have impacted 3 million households with incomes over $US250,000. Their full 2011 taxes would have been around $US45 billion higher, or 2.2% of income. For 2.1 million households with $US250,000-500,000 in income, additional taxes would have been around $US3 billion (around $US1500 per return on average income of $US335). For 900,000 households with incomes over $US500,000, additional taxes would have been around $US42 billion (around $US50,000 per return on average income of $US1.5 million).
Additional taxes on 2013 income are likely to be larger as equity markets hit new highs in 2013 and dividends are up 30% from 2011. Assuming wages are up 3%, all investment income is up 10%, personal exemption amount is up 5.4% ($3900 in 2013 from $US3700 in 2011), and qualified dividends and capital gains are up 30%, we estimate that taxes are around $US50 billion higher for all of 2013, of which around $US35 billion are due in April. Over the last 10 years, 60% of individual income taxes not withheld were paid in April. This year, we estimate that it will be closer to 70%, as most of the increase in taxes involves dividends and capital gains.
Guillermo Roditi Dominguez, a portfolio manager at New River Investments, has raised the possibility numerous times on Twitter that tax selling would emerge as a theme in the markets this month.
Below are a few of his tweets on the subject.