Obama’s Fiscal Cliff: The Effects of Taxing Wealth

Below is an article which “confirms my bias” or compounds on what I wrote last Sunday about the recent US stock market selloff as an outcome of rising political risks or regime uncertainty from President Obama’s soak the rich policies.

From the CNBC 

For many of the wealthy, 2012 is becoming a good year to sell.

They're worried about the "fiscal cliff," which is when tax cuts expire and spending cuts are set to go into effect at the end of the year.

Fearing an increase in capital gains and dividend taxes, many of the rich are unloading stocks, businesses and homes before the end of the year.

Wealth advisors say that with capital-gains taxes potentially going to 25 percent from 15 percent, and other possible increases in the dividend tax, estate tax and other taxes, many clients are selling now to save millions in taxes.

“Under almost any scenario, it makes sense to take the gains this year,” said Gregory Curtis, chairman and managing director of Greycourt & Co. “Clients aren’t selling willy nilly. But if they can and they have a huge gain, they’re selling now.”

Capital gains taxes represents a tax on wealth. In essence if you tax something you get less of it.  Thus an increase in capital gains taxes dissuades investors and entrepreneurs to undertake productive activities which becomes a hindrance to capital accumulation and to wealth generation.

So capital gains hike will have lasting adverse  effects

Raising dividend taxes also will hurt stock market investors.

The level of dividend tax rates affect dividend issuance. According to the Wall Street Journal

Historical experience indicates that corporate dividend payouts are highly sensitive to the dividend tax. Dividends fell out of favor in the 1990s when the dividend tax rate was roughly twice the rate of capital gains.

When the rate fell to 15% on January 1, 2003, dividends reported on tax returns nearly doubled to $196 billion from $103 billion the year before the tax cut. By 2006 dividend income had grown to nearly $337 billion, more than three times the pre-tax cut level.

Next a swath of investors will get hurt, not limited to the scorned “wealthy”. From the same article

IRS data show that retirees and near-retirees who depend on dividend income would be hit especially hard. Almost three of four dividend payments go to those over the age of 55, and more than half go to those older than 65, according to IRS data.

But all American shareholders would lose. Higher dividend and capital gains taxes make stocks less valuable. A share of stock is worth the discounted present value of the future earnings stream after taxes. Stock prices would fall over time to adjust to the new after-tax rate of return. And if investors become convinced later this year that dividend and capital gains taxes are going way up on January 1, some investors are likely to sell shares ahead of paying these higher rates.

The question is how this helps anyone. According to the Investment Company Institute, about 51% of adults own stock directly or through mutual funds, which is more than 100 million shareholders.

So again, unless there will be a bipartisan deal reached, US stock markets will remain highly vulnerable to sharp downside volatility.

And President Obama will increasingly rely on team Bernanke and the FED to offset the effects of wealth destructive policies.

Ironically while Mr. Bernanke has been doing his darned best to keep asset markets afloat, Mr. Obama has been undoing them. Such paradox accounts for as the proverbial "the left hand does not know what the right hand is doing". That's the way of politics.