The talk about Bush-era tax cuts has subdued recently, but it will definitely resurface. When it comes to investing, Bush-era tax on dividends and long-term capital gain has played a major part in how investors position their portfolios. This was an opportunity to take home more of your investment earnings. What will change if these tax cuts are no longer around?
Let’s not over complicate the answer to this question. The answer is simple, your take home will be lower. However, is this reason enough to reallocate your portfolio or stop investing? Not for the ’99 percent’. Sorry for using this term, however in this case it applies perfectly. Who had a sizable benefit from the lower taxes on dividends and long-term capital gains? Those who pretty much live off of their investments. Those are likely to be very wealthy individuals, what a lot of people call ‘the one percent’ these days. However, it is highly doubtful that the expiration of tax cuts will hurt them deeply; they will find another way to take home more. After all, that is partly why they are wealthy. They find a way.
As for ‘the 99 percent’, it will not likely to have a huge effect. Let’s assume there is $1000 in dividends earned by an investor. Right now, the investor will take home $850 (15 percent tax rate). If the tax rates go up the investor will pay his/her income tax rate on those dividends. Let’s say the tax rate for the investor is 33% (highest rate right now). In this case investor takes home only $666. Percentage wise, it is a hit, dollar wise not so much.
At the end investors will have to ask themselves a question. Should they pay more in taxes and still have some sort of investment income? or should they forgo that additional income? It is unlikely the latter. Now of course, lack of additional benefit will make some investors to adjust their portfolios to more growth as opposed to value oriented stocks. After all the name of the game should be make as much as you can and take home as much as you can. If you have a stock that pays 5 percent dividend and returns 10 percent over a 12 month period and you have a growth stock that pays no dividend but returns 25 percent over the same period, which investment would you chose since tax treatment is the same?
Now when it comes to capital gains it is pretty much the same. This time however, there will be less of a benefit for investors to buy and hold, at least from the tax perspective. If anything, financial markets may experience a side effect. That side effect additional volatility. If an investor realizes a capital gain sooner, that investor has no benefit of holding the security for longer to get a better tax treatment, hence will make sense to sell quick and reinvest into another opportunistic place.
So, even though effectively the tax rate goes up, if Bush-era tax cuts expire, investors will still be looking to make money, and will likely continue to invest without much change to their portfolios. If anything, investors will pay more attention to picking the investment with the most potential.