This article was originally posted on Smart Money by an author unaffiliated with Capital Investment Advisors.
When stock prices slide and gains evaporate, investors are usually left with the meager consolation of smaller tax bills. If a long stock decline were to hit now, however, investors could easily be required to pay more.
The problem is that the stock market has become an important source of consumer stimulus and government revenues, and bullish assumptions about stock returns have been built into state pension math. A prolonged market downturn could thus set off a chain of effects that would end with sharply higher income taxes.
First, consider the background. Federal debt held by the public has swelled 81% in three years to $9.8 trillion as of Monday. In March, the Congressional Budget Office projected that the U.S. will run deficits of (and therefore have to borrow) about $7 trillion between 2012 and 2021. Tuesday's signing of the Budget Control Act of 2011 will ultimately reduce this amount by at least $2.1 trillion, the CBO estimates. That leaves nearly $5 trillion in looming deficits to deal with. However strong the case for spending cuts, tax hikes seem inevitable, because federal revenues are low by historical standards -- 15% of gross domestic product, versus an average since 1970 of 18%.
Enter falling stock prices. The most immediate effect is on capital gains taxes, receipts for which have varied sharply since 1995, from nearly 12% of individual income taxes during the dotcom stock bubble to half that much following the housing crash. Unsurprisingly, the budget surplus from 1998 through 2001 and the deficit reduction from 2004 through 2007 coincided with two periods when capital gains tax receipts were highest. The CBO projects that capital gains tax receipts will rise from $56 billion last year to more than $100 billion a year from 2013 on. If those gains don't materialize, deficits will grow faster than expected, increasing the need for more taxes, spending cuts, or both.
Read on Smart Money: http://www.smartmoney.com/invest/stocks/why-taxes-will-jump-if-stocks-drop-1312407910710/?link=SM_taxes_featStory. This article was originally posted on Smart Money by an author unaffiliated with Capital Investment Advisors. As a part of our effort to disseminate important relevant information to our clients, we frequently post articles from other sites on topics of interest. The information posted in this article does not necessarily reflect the views of our firm.
