The Big Bad Tax Hike—Calming Client Fears
The Biden administration has made no secret of its intention to effect tax hikes, identifying the two prime targets as corporations and individuals making more than $400,000 annually. While it remains unclear just how much of this tax-raising agenda can progress from proposal to law, your clients are being told daily by the talking heads that big, bad tax changes are on the way. Tax hikes may well be on the way, and soon. Still, those increases may not be the obstacle that many investors expect, according to Fidelity Viewpoints. Other economic factors may play a more important role, especially when sizable federal spending serves as an offset. Innovative Portfolios Managing Director Dave Gilreath tends to agree. “The global economy is a good policeman of tax rates,” Gilreath says, with money flowing to where “it’s treated best.” If tax rates in the U.S. are judged to be “too high,” capital will flow to other countries.
As the chart below illustrates in a review of the past 70 years, there has been a strong correlation in timing between hikes in government spending on social welfare programs and hikes in tax rates.
During the four capital gains tax hikes in the last half-century, Gilreath reminds investors, the S&P initially reacted by falling around 3% in the months leading up to the law’s passage. Once the tax increase had passed into law, the S&P went on to gain an average of 15% in the ensuing half year. All these historical look-backs notwithstanding, your clients, (particularly “residents of Affluentville” with personal wealth averaging $3-10 million) remain edgy, and financial advisors are rallying to turn down the panic dial. Writing in Financial Planning Magazine, Lynnley Browning points out that even if, as part of the tax hike, the capital gains rate were to be almost doubled (as Biden is proposing), things aren’t going to be that way forever. Furthermore, Browning suggests clients be proactive, “blunting or eliminating” a tax sting by carefully timing when they cash out paper profits. UBS Chief Investment Officer of the Americas Solita Marcelli comes at the issue of proposed tax hikes from a different angle: “You can manage your tax burden today and in the future,” he observes, “by investing more of your wealth into tax-deferred accounts.” All well and good to calm investor fears, but what is likely to be the effect on the overall stock market of tax hikes? “Tax haters across Wall Street are in a panic,” Lynda Moynihan ventures in the New York Post, citing fears that the Biden tax hikes will be retroactive, “sticking taxpayers with jacked-up rates on transactions dating back to Jan 1” of this year. Americans may be scrambling, Julians Kaplan opines in the Business Insider, but a capital-gains-tax hike probably won’t affect the stock market, quoting a note from UBS Gobal Wealth Management: “History shows no relationship between capital gains tax rate changes and stock market performance.”
Indeed, Dave Gilreath says. It’s not tax hikes, but reacting to them in fear invoked from listening to news and commentary that can be punishing to any investment portfolio. As history appears to demonstrate, corrections caused by headlines—even those about impending tax hikes—are often relatively short-lived.