Q&A; : Tax-Favored Investments Looking Good

President Clinton’s economic plan is far from becoming reality, but already it is dramatically affecting investors.

Clinton’s plan to hike tax rates for high-income individuals is giving a lift to Lebenthal & Co., a New York-based brokerage specializing in selling municipal bonds. Thousands of people are turning to these tax-favored investments, Chairman Jim Lebenthal says.

Bruce Kaplan, a Santa Monica gold dealer, says survivalists are buying gold and platinum coins by the millions to use for barter when, they predict, our economic system disintegrates.

But investors in stocks of big companies--who lost when the stock market tumbled sharply Tuesday--are concerned that their investments may fall further amid worries that proposed tax hikes will kill the fledgling economic recovery.

How will the President’s plan affect your investments? Here’s a question-and-answer look:

Q. What tax breaks does Clinton want to create?

A. He wants a limited capital gains tax cut. If you buy a new issue of stock in a company that has capital of less than $25 million, and hold that stock for five years or more, you can exclude up to 50% of your gain from capital gains taxes, according to Clinton’s plan.

Clinton is also expected to liberalize “passive-loss” rules, which would allow those who own investment properties such as apartment buildings to write off more of their costs.

Q. Will the capital gains tax cuts boost small-company stocks and initial public offerings?

A. That’s hard to say. The capital gains break on newly issued shares is clearly designed to help start-up firms.

But the market for IPOs will be greatly affected by how the overall stock market performs. If stocks as a whole suffer, IPOs will probably suffer too.

Q. Why would stocks in big companies be hurt?

A. Clinton wants to raise corporate tax rates and curb deductions for a variety of traditional write-offs, including high executive salaries and certain other business expenses.

There is also some fear that his plans to raise taxes and cut spending will scuttle the nation’s economic recovery, which would reduce corporate sales and harm company earnings.

Q. What investments look attractive now?

A. Anything that gets tax-favored treatment, including municipal bonds, certain life insurance products and tax-favored retirement accounts such as individual retirement accounts and 401(k) savings plans.

With higher taxes, the value of such tax shelters rises.

Owners of already issued government and corporate bonds could benefit if Clinton succeeds in driving down the federal deficit and interest rates. That would make existing, higher-rate bonds more valuable.

Ironically, some experts also believe that gold will benefit, even though prices of other commodities may fall because Clinton’s plan is anti-inflationary.

Q. Why would gold do well?

A. In part because returns on other investments may look more lackluster.

If interest rates fall, returns on certificates of deposit and other savings vehicles are likely to drop.

Yields on newly issued bonds are also expected to slide. And a greater portion of investment returns are likely to get taxed away.

Also, gold usually does well in times of economic turmoil because, at least in theory, it retains its value through thick and thin.

There’s also a segment of the population that buys gold believing that someday our current economic system will fall apart and they’ll need “hard currency” to buy goods and services.

Q. What investments look riskier now?

A. Possibly stocks. The stock market has been fueled in recent months by expectations that the economy was recovering and companies would report dramatically improved earnings. If the economy slides back into the doldrums, those earnings expectations could be shattered--and so could stock prices.

Stocks in certain industries are expected to be hit harder than others. Transportation companies could be hard hit by Clinton’s proposed energy tax.

Health care concerns may suffer from lower reimbursement rates for Medicaid patients.

And manufacturers and retailers of nonessential goods--almost everything other than food--may suffer if Americans curb spending because of higher taxes.

Q. Are there any stocks that could do well despite risks to the overall market?

A. Some expect environmental concerns to clean up with an environmentally sensitive Administration. And technology concerns may be boosted by investment tax credits and tax breaks for research and development.

Q. What about municipal bonds? How attractive are they?

A. High-income individuals who live in high-tax states such as California may find after-tax yields on these bonds particularly compelling.

Intermediate-term munis are now yielding about 5.5%, says brokerage chief Lebenthal. At today’s tax rates, that is equal to an 8.85% yield on a taxable investment for a Californian who also pays about 10% of his income in state taxes, Lebenthal adds.

If Clinton’s proposals go into effect as planned, that equivalent muni yield would rise to 9.54% on a taxable investment.

Q. Which segments of the muni market look better than others?

A. Triple-A, insured bonds are probably the best bet, according to Lebenthal. Insured bonds are in great supply, so the yield doesn’t suffer much for the added security. And, in tumultuous economic times, added security is worthwhile.

Q. What will be the impact on real estate investments?

A. Investments in single-family residences are not directly affected. But if tax rates rise, mortgage interest deductions would become relatively more valuable.

The proposal to liberalize passive-loss rules could make investment in real estate a bit more attractive.

Q. What will be the impact on the U.S. dollar?

A. If the economy stumbles and interest rates decline, the value of the dollar is also likely to fall.

That would boost the value of foreign stocks and bonds.