This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

A Taxing Issue for Investors

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- The 2012 elections hold major consequences; one of them is tax policy. While there is much that we could present regarding the potential changes, we will constrain our comments to how tax changes may directly affect investors in the stock and bond markets.

Already written into law for 2013 are big changes including the expiration of the Bush tax cuts and the payroll tax cut and the new Medicare tax on investment income, not to mention the impact of the increasingly costly annual fix to the alternative minimum tax. However, this default option may instead be replaced by something else.

  • President Obama has devoted a lot of his recent campaigning to highlighting his preference for the so-called "Buffet rule," which places a top minimum tax rate on capital gains of 30% and, combined with other changes, produces a top rate of 43.4% on dividends and interest income.
  • Alternatively, included in the Mitt Romney supported House Republicans' proposal is a cut to the top income tax rate that would apply to interest income to 25% and maintain the 15% rate on dividends and capital gains.
  • The outcome is likely to be somewhere in the middle of the wide range between these two proposals. Given the scale of the changes, it may be surprising to note that we do not expect major direct impacts of tax changes on the stock or bond market. The far bigger impact is an indirect one determined by the magnitude and direction of overall fiscal policy taken (or not taken) in 2013 to put the United States back on a path to financial stability.

    Bond Market Tax Rate Impacts

    Historically, changes in income tax rates that apply to interest income appear to have had little, if any, direct impact on government bond yields. Yields rose with inflation in the 1970s and fell as inflation fears receded over the vast majority of the last 30 years regardless of tax code changes or their impact on the deficit.

    Over the past 30 years, municipal bond yields traditionally traded at a discount to taxable bond yields. However, in recent years credit fears driven by macroeconomic events have resulted in a breakdown of the historic spread between taxable and non-taxable municipal bonds. Municipal bonds now trade at yields in line or above those of their taxable Treasury counterparts. The potential for higher income tax rates applied to interest income is likely to make municipal bonds even more attractive to investors as credit fears fade.

    Stock Market Tax Rate Impacts

    Tax changes have also had minimal effects on stock market performance. To illustrate, we can look at the two most important drivers of stock market return: earnings growth and valuations.

    Generally, higher taxes mean less of an incentive for individuals to work, invest, take risks to create value and become entrepreneurs. It can also mean less disposable income to spend on goods and services. However, income tax changes have not had much measurable effect on earnings growth.

    Earnings growth is very cyclical -- it falls sharply during recessions and rebounds early in expansions to average about a 7% growth rate over the full cycle. This has been consistent regardless of the prevailing tax rates. In fact, the growth rate of earnings from the peak of one business cycle to the next has consistently been about 7% over the six major earnings cycles spanning the past 50 years, despite average top marginal income tax rates that ranged from 91% at the beginning of the period to the current 35% and corporate tax rates that ranged from 52.8% to 34%.

    Earnings and Taxes

    1 of 3

    Select the service that is right for you!

    Action Alerts PLUS
    Try it NOW

    Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    • Weekly roundups
    TheStreet Quant Ratings
    Try it NOW
    Only $49.95/yr

    Access the tool that DOMINATES the Russell 2000 and the S&P 500.

    Product Features:
    • Buy, hold, or sell recommendations for over 4,300 stocks
    • Unlimited research reports on your favorite stocks
    • A custom stock screener
    • Upgrade/downgrade alerts
    Stocks Under $10
    Try it NOW

    David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    • Weekly roundups
    Dividend Stock Advisor
    Try it NOW

    Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

    Product Features:
    • Diversified model portfolio of dividend stocks
    • Alerts when market news affect the portfolio
    • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
    Real Money Pro
    Try it NOW

    All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

    Product Features:
    • Real Money + Doug Kass Plus 15 more Wall Street Pros
    • Intraday commentary & news
    • Ultra-actionable trading ideas
    Options Profits
    Try it NOW

    Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

    Product Features:
    • 100+ monthly options trading ideas
    • Actionable options commentary & news
    • Real-time trading community
    • Options TV
    To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
    Submit an article to us!


    DOW 17,804.80 +26.65 0.15%
    S&P 500 2,070.65 +9.42 0.46%
    NASDAQ 4,765.38 +16.9840 0.36%

    Brokerage Partners

    Rates from

    • Mortgage
    • Credit Cards
    • Auto

    Free Newsletters from TheStreet

    My Subscriptions:

    After the Bell

    Before the Bell

    Booyah! Newsletter

    Midday Bell

    TheStreet Top 10 Stories

    Winners & Losers

    Register for Newsletters
    Top Rated Stocks Top Rated Funds Top Rated ETFs