FRIDAY MARCH 19, 2010

Taxing Investment

While most of the country is focused on the wild, down to the wire finish of the healthcare debate, investors should take notice of a new tax on "investment income", specifically dividends and capital gains.  The current iteration of Healthcare, at least what we are told since there still is no bill,  applies a 3.8% Medicare tax to investment income.  This is up in just the last week from a 2.9% tax.  Keep in the mind, the "Bush tax cut for the rich" will expire at the end of this year.  That means that the current 15% tax on investment income is going to go up to at least 20% and proposals are out there to move it to 25%.  Combine the two tax events, and the new rate on capital gains will approach 25% or more!

These changes will have an impact on the stock market.  Historically, whenever the capital gains rate is increased, investors accelerate their sales of stocks with unrealized gains in order to take advantage of the current lower rate.  This results in selling pressure on the overall markets.  This acceleration also diminishes the revenue generated from the investment income in the future, so the projected revenue from the tax increase rarely meets the budget and therefore will lead to further deterioration in the deficit numbers.  If enacted, this 66% increase in taxes on investment will put pressure on stock prices, particularly in the last months of the year.   Selling pressure will be acute in recent high-flying stocks, as investors flock to diversify their portfolios of concentrated positions.

Lastly, all of these new taxes on the wealthy are making Municipal bonds more attractive by the day.  As taxes increase across the board, particularly on stock appreciation and dividends, the tax-exempt income generated by Munis becomes more attractive.  While investors need to be concerned about the fiscal status of many state governments, the increase in demand for tax-exempt income is providing a counter-balance. 

POSTED AT 1899-12-30 08:50:00.0

KEN ENTENMANN, CFA
SENIOR VICE PRESIDENT AND
THE DIRECTOR OF INVESTMENT MANAGEMENT SERVICES

Ken is a Senior Vice President and the Director of the Trust and Investment Services at Alliance Bank, N.A. He has 23 years of investment experience and oversees the management of assets totaling $1 billion. He holds a B.S. in Applied Economics and Business Management from Cornell University and an M.B.A. from the William E. Simon Graduate School of Business Administration at the University of Rochester. He has also earned his Chartered Financial Analyst designation. He is a member of the Executive Committee of the Trust Division of the New York Banker's Association. He is also a director of the Central New York Community Foundation.

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