Brace for Reversion to the Mean

Solution: Cut dividend taxes to zero. It wouldn't be an instant panacea for all the market ills, but it would favorably alter the metric of how the future stream of corporate earnings and dividends are valued. Just imagine buying Coca-Cola (KO - commentary - Cramer's Take) and earning a tax-free dividend of 3.7% that grows like clockwork. That starts to become a very compelling alternative to muni bonds that offer a static yield with interest rate and call risk.

There's one more pro-shareholder benefit, and it's a big one. Corporate boards would have an incentive to pay bigger dividends in lieu of wasting billions on poorly conceived share buybacks.

A 2003 article by the Tax Policy Center put a $20 billion price tag on the elimination of individual taxation of dividends. So let's call it $25 billion today. The way the Treasury is throwing money around, that's pocket change. I don't favor temporary plans, though -- I want this one to stick. Therefore, I suggest that in two years, marginal income rates be increased slightly to make the adjustment revenue-neutral. Since the large majority of the direct benefit would go to upper-income households, a 1.2% increase to income tax rates for those earning over $200,000 would provide an approximate offset.

It's rare to find a tax shift that's a win-win for just about everyone, but this could be it. Those earning more than $200,000 pay additional income taxes but benefit from a rise in accumulated wealth through higher stock valuations as well as the ability to generate ongoing tax-free income on equity holdings. For all other income groups, it's a no-brainer.

Altering Investment Strategies

Because I don't expect Washington to pursue my mean-reversion trajectory idea, we must control that which we can control. For that reason, one might consider materially reducing exposure to the equity markets but gaining limited exposure to individual ideas that can really ramp if things break right. With the current lift in the broad indices, Mr. Market is making this strategy more palatable for those who weren't positioned defensively ahead of the drubbing.

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At the time of publication, Masino was long ICO, but positions can change at any time.

Rich Masino is president of Private Investor Research and editor of The Substantial Investor. He is a private investor who manages a family long/short investment portfolio that holds numerous positions across a variety of asset classes.

Before starting Private Investor Research, Mr. Masino co-founded a telecommunications company that grew to 500,000 customers. He sold all of his interests in the company in 1998.

He holds an MBA in finance from St. John's University.