The Effect of Republican’s Offer to Raise Taxes on Million Dollar Incomes on to the Economy

 

House Speaker Boehner offered on December 14 to raise taxes on those earning over $1,000,000 to avoid a breakdown in Congressional Fiscal Cliff negotiations.

This means the Republicans have caved in to the Democrats and will agree to tax increases. Starting a tax increase during a recession is a classic economic error that will make the recession worse. This will make bond prices go up and stocks go down. At first the stock market will celebrate an orderly conclusion of the negotiations and may go up in a bubble. But ultimately it will fall back down to its intrinsic value.

Artificially low interest rates have facilitated corporations’ ability to borrow money and fund stock buybacks which has made stock prices go up for artificial reasons. Ultra-low interest rates have enabled speculators to buy stocks on margin. However, when a crash comes they may encounter forced margin sales at fire sale prices, making the crash deeper than it needs to be, thanks to excessive debt.

The risk is that a 401k, if it holds stocks, could be hurt by a crash that was a result of the Fiscal Cliff negotiations.

Another aspect is that this could push more small businesses into becoming multinational corporations with subsidiaries in Ireland, Switzerland, etc. so that the owner can have his corporate income taxed at 8.8% to 12%. In some cases the income can legally be taxed in the Bahamas at 0%. Of course when the subsidiary repatriates the income then it is fully taxed, unless Congress offers a tax holiday. In this case the U.S. would get less tax revenue as a result of this restructuring and more dollars would be spent overseas instead of at home.

If everyone who earns over $1,000,000 was able to structure their business as a multinational corporation then the effect on the tax increase would be less drastic than if the income was simply taxed away. The business must be an operating business that provides goods and services and not simply a passive portfolio of shares of stocks and bonds. However, the foreign subsidiary is required to not lend the money to its parent so the funds could not be spent. The funds could be invested, so the owner could have the subsidiary take title to publicly traded stocks and bonds held in a brokerage account owned by the subsidiary. In that case there would be no net change in ownership of stocks in the economic bug picture and then there would one less reason for stocks to crash. Further this would give the owner extra money to buy more stock. So less consumption would occur (because the funds need to be kept in the subsidiary) and more investing could result, if the new tax proposal resulted in more foreign subsidiaries. Of course it would provide more employment for tax attorneys and CPA’s which would stimulate the economy.

I have written an article “Can a Black Swan Attack Your 401k?”

Investors should seek independent financial advice.



Tax aware investing

 

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