In a Nutshell

By Ken Herman

Who Will Pay for Growing Federal Government Spending?

"So, what do we do now?  My answer is always the same: Look at the data."

Certainly the rich are expected to pay heavily!  So much tax increase news quickly and significantly hurt sentiment on Wall Street. The markets turned south towards the end of what had been a positive session (due to unemployment claims reaching a pandemic low).   All of the major stock indexes ended that day down 1%, though some cautioned it may be a “knee-jerk reaction” because the upcoming proposal could be hard to pass in Congress.

“We’re still finalizing what the pay floors look like” (whatever that means) White House Press Secretary Jen Psaki told reporters in response to questions about deterring long-term investing.  “The president’s calculation is that there is a need to modernize our infrastructure, invest in childcare and early childhood education, and he should propose a way to pay for it.”  She went on to say: “His view is that it can be on the backs of the wealthiest Americans, as well as corporations and businesses, who can afford it, and that won’t have a negative impact.  There are alternative views, and there are proposals that don’t exist yet on how to pay for it.  That will be part of the discussion”.

Biden’s proposals on capital gains tax increases would only affect the federal rate. Wealthy individuals who live in California and New York, which tax capital gains as regular income at 13.3% and 11.85% (plus 3.88% in NYC), could see total capital gains duties of nearly 60%!  How much will these much higher taxes shake up markets?  While the wealthiest top 1% have always controlled 70% to 80% of stock market value in the U.S. (according to the Federal Reserve), the top 10% of households by net worth owned 87.2% of American equities in 2020, the highest level of such ownership ever.

To stay ahead of the stock market curve and net after tax benefits, humans have thought about fast money opportunities ever since money was invented.  Even the most conservative types dream of a sudden windfall.  As they say, “You’ve got to be in it to win it!”  It follows that when the stock market doesn’t do what we want it to do, we get impatient.  That often turns to frustration, which leads to impulse… then, we often do the wrong thing at the wrong time.  Recently stocks have been frustrating.  Those we want to rise don’t, and ones we think shouldn’t go up do.

So, what do we do now?  My answer is always the same: Look at the data.  I learned the hard way that my emotions are my single worst investing indicator.  The best advice I can offer is let your emotions cool off before reacting.  Stocks trade radically due to the overreaction of emotional sellers.  Traders know this and they let their bids drop more than they would normally when they see an emotional sell wave coming.  Traders will usually bring stocks back with a stronger offer (price) based upon their position, understanding reasons why the weakness occurred as well as the future outlook in that stock.

All this higher tax talk is targeted to pay for Biden’s $2.25 trillion so-called “infrastructure” plan.  If the money doesn’t come from corporations, then it will come from other sources in the form of higher individual income taxes, eliminating qualified dividends, eliminating step-up basis for estates (meaning taxing unrealized capital gains), new gas/carbon taxes, and possibly a national Value-Added Tax (VAT) at some point.

Whatever the end game is for policymakers, taxes for corporations and for individuals are expected to increase by varying but significant degrees.  To date the stock market has paid little attention to this soon-to-be ugly reality. At some point it would seem that this “in-process” transformational change in tax policies will matter to the stock market – but then again, maybe not.