Banks are just the first target on the tax agenda
President Obama has proposed what may be the most popular tax increase in American history: He wants the biggest banks to fork over about $9 billion a year for the next decade via a “financial crisis responsibility fee.”
“We want our money back, and we’re going to get it,” Obama declared Thursday.
That probably was something of a shock to Goldman Sachs Group Chairman Lloyd Blankfein, for one. He must have figured he had paid in full in July, when Goldman wrote checks for $11.1 billion to return government capital received in 2008 under the financial-industry bailout program.
The public sheds no tears for the megabanks, of course. But you could view Obama’s “responsibility fee” as the opening act for a year of tax changes that many consumers and investors are much less likely to welcome.
So far, the stock market doesn’t seem terribly focused on tax issues, as the 10-month-old rally rolls along with only infrequent, and minor, hiccups. But the year is young and the tax agenda is loaded.
The biggest tax question in Washington centers on the cuts signed into law by President Bush in 2001 and 2003, due to expire on Dec. 31. Without congressional action, the top federal marginal tax rate would rise back to 39.6% from the current 35%, and the lowest tax rate would jump to 15% from 10%.
The sunset of the Bush cuts also would push the maximum tax rate on long-term capital gains back to 20% from 15%.
The biggest change would be felt by many investors who are used to paying a top tax rate of 15% on stock dividend income. Dividends would revert to being taxed at ordinary income tax rates, which would be a significant blow to higher-income earners.
Investors and savers also would be targeted under an idea that emerged in recent days to help fund the Democrats’ proposed healthcare reform package. Some Democrats want to apply the 2.9% Medicare payroll tax not just to wages but also to dividends, capital gains, bond interest and other unearned income, though perhaps just for high-income earners.
Meanwhile, the House and Senate will have to decide what to do about the estate tax. The tax, which totaled 45% on estates worth more than $3.5 million for singles and $7 million for couples, expired last year because the Senate failed to act on it.
Another big question mark: How many cash-strapped state and local governments will try to boost revenue this year by raising taxes or fees? Last year, nine states -- including California -- increased personal income tax rates, according to the Tax Foundation. Seven states, also including California, raised sales taxes last year; 18 raised taxes on the usual target, cigarettes.
In the case of the Bush tax cuts, there are reasons to believe that a significant portion of those rollbacks could be preserved. Obama is expected to hold to his 2008 pledge not to raise taxes on families earning less than $250,000, though he has said he would push to restore higher tax rates on people making more than that.
Likewise, the White House has signaled that it wants to keep the low Bush tax rates on capital gains and dividend income for families earning less than $250,000 and singles earning less than $200,000.
Higher-income earners would pay more, but the White House has indicated that it would settle for a 20% maximum capital gains and dividend tax rate for that group.
Although conventional wisdom is that any tax increase would be negative for financial markets, even conservatives concede that history doesn’t allow them to make a consistently reliable connection. There are just too many other factors that push and pull on investment values.
“You can’t draw a straight line . . . the way you can in physics,” said J.D. Foster, a tax expert at the Heritage Foundation in Washington.
After all, people make investment decisions for reasons that often have nothing to do with taxes. Last year, for example, individual investors bought corporate and U.S. government bond mutual funds in record amounts, even though income on those securities gets no favored tax treatment, unlike stock dividends.
What’s more, many people invest solely via tax-deferred 401(k) accounts. That eliminates any need to think about investment-specific tax issues, at least up front.
On a macro level, liberals typically point out that the economy and markets boomed in the late 1990s despite the Clinton administration’s income tax hikes of 1993.
But conservatives like Foster are quick to note that the capital gains tax rate was cut to 20% from 28% in 1997 in a move pushed by Republicans and ultimately supported by President Clinton.
Liberals try to turn the case for maintaining lower taxes against the Republicans by citing the U.S. economy’s relatively weak performance in the last decade.
“The argument for keeping tax rates low is that you get better growth,” said Michael Ettlinger, vice president for economic policy at the liberal Center for American Progress in Washington. “But in the 2000s, it just didn’t pan out.”
What’s impossible to know, however, is whether things would have been far worse for the economy and markets without the Bush tax cuts.
For many Americans, the best argument -- maybe the only argument -- for higher tax rates in 2010 would be the need to deflate the ballooning federal budget deficit. That was a crucial element of the case for the Clinton tax increases of 1993.
Whether by policy or just good luck, the deficit did indeed shrink in the 1990s and briefly turned into a surplus by the end of the decade.
But the great risk in trying to use tax increases to drive down the deficit today is that many Americans, even the well-off, are in weak financial positions because of their debt loads, dwindled investment accounts and lack of wage growth. Cut income further, and consumption could dive.
U.S. Chamber of Commerce President Tom Donohue stirred that pot with gusto this week, warning in a speech that the Obama administration’s plan for tax increases and new regulations on businesses is “a surefire recipe for a double-dip recession, or worse.”
For investors who believe that 2010 will bring enough tax hikes to sink the economy, there shouldn’t be much debate about what that would mean for stock prices. A turn back to recession -- and tumbling corporate earnings -- wouldn’t support a Dow Jones industrial average of 10,600.
Even if the economic recovery and the stock market’s revival survive any tax increases this year, some Wall Street pros say that rising tax rates should be viewed in combination with other potential threats to the market’s long-term health.
Jason Trennert, chief investment strategist at Strategas Research Partners in New York, figures there are four principal variables that affect the prices investors are willing to pay for stocks relative to companies’ underlying earnings: taxes, regulation, interest rates and inflation.
For much of the last 30 years, he notes, all four of those variables were declining, helping to fuel what was a spectacular run for stocks in the 1980s, 1990s and even 2000s (for many issues) before the crash of 2008.
The challenge to the case for a powerful long-term bull market, Trennert says, is that all four of those variables seem to have only one way to go from here: up.
