During the fall of 2012, some experts warned that raising taxes on capital gains and dividends would be bad news for the markets.
Here’s Deutsche Bank’s David Bianco on some of the history:
Higher taxes undoubtedly contributed to very poor S&P 500 performance
The long-term capital gains rate climbed from 25% in 1967 (since 1942) to 39.9% in 1977. The 1976 Act also eliminated inherited property basis step ups. Although postponed and ultimately repealed in 1980, seemingly lost inheritance step ups and higher capital gains rates amidst double-digit inflation represented a huge tax hike. This undoubtedly contributed to PE compression and very poor S&P 500 performance from 1968 to 1978.
Well, the U.S. government eventually passed the “American Taxpayer Relief Act of 2012” (ATRA), which raised the tax rate on dividends and capital gains by 5% for the folks in the top tax bracket.
But in 2013, we saw the stock market book a whopping 30% return.
So, did the market clear that hurdle?
It’s quite possible that the rich folks affected by the tax hike largely ignored the tax hike because it didn’t affect them … yet.
Perhaps now that they’re filling out their tax returns, they’re finally realising how much more they owe Uncle Sam. Perhaps some of those folks are now dumping some of their stocks to pay for these taxes. Perhaps that’s why we’re seeing all of this out-of-the-blue volatility in the markets in the last month.
This is a theory that had been floated by New River Investments’ Guillermo Roditi Dominguez. And it’s something that Bianco delved into in his latest note to clients.
“Additional taxes in 2013 income are likely to be larger as equity markets hit new highs in 2013 and dividends are up 30% from 2011,” said Bianco. “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 ~$50bn higher for full 2013 of which ~$35bn 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 increase in taxes involves dividends and capital gains.”
It might not be the primary factor driving the sell-off. But it’s hard to see how any of this would be a positive.