In a Nutshell: When the Other Shoe Drops…

May 2021


By Ken Herman


Who will get stuck with the bill for the federal government’s spending spree?

 

Certainly, the rich are expected to pay heavily. The volume of tax-increase news quickly and significantly hurt sentiment on Wall Street as President Biden began to outline the contours of his spending agenda in April. As he did, the markets turned south towards the end of what had been a positive session (due to unemployment claims reaching a pandemic-era low). All of the major stock indexes ended that day down 1 percent, though some cautioned that it might 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 said in response to media questions about deterring long-term investing. “The president’s calculation is that there is a need to modernize our infrastructure, invest in child care 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 Cali-fornia and New York, which tax capital gains as regular income at 13.3 percent and 11.85 percent (plus 3.88 percent more in New York City), could see total capital gains duties of nearly 60 percent! 

How much will these much higher taxes shake up markets? While the wealthiest top 1 percent have always controlled 70 percent to 80 percent of stock market value in the U.S. (according to the Federal Reserve), the top 10 percent of households by net worth owned 87.2 percent 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 since the invention of money. 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 an-swer 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 erratically because of overreactions by emotional sel-lers. Traders know this, and they let their bids drop more than they normally would 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 occur-red as well as the future outlook in that stock.

All this talk of higher taxes 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 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 pol-icies will matter to the stock market.

But then again, maybe not.