Domestic Taxes

Report shows 8.6 percent drop in stock market if Bush tax cuts expire

Barry Knapp, who heads up the
U.S. Portfolio Strategy at Barclays, told The Hill that the percentage drop
could also be attributed to the Dow Jones Industrial Average. 

“If you assume the
relationship between the Dow and the S&P 500 is stable, which it is over time,
than that’s fair,” he said. 

The S&P 500 has become
the primary indicator for the health of the overall U.S. stock market by
reflecting the activities of large-cap companies and is considered one of the
most renowned indexes since the Dow reflects only the actions of 30
companies. 

The Barclays’ study focused
on the S&P index and how it would be affected by the 15 percent tax on
capital gains and dividends resetting to 20 percent for capital gains and 39.6
percent on dividends, which is expected to occur Jan. 1 when all tax cuts
enacted by President George W. Bush expire. 

In technical terms, the study
looked at the relationship between the effect of higher taxes on
price-to-earnings ratio (P/E) multiples over the next couple of years. 

“We concluded that the
current plan to change [taxes] would result in one P/E multiple point reduction
in the S&P 500,” Knapp said. 

That reduction translates
into an 8.6 percent drop in the S&P over time. 

The S&P on Wednesday
closed at 1,106, meaning the scheduled tax increase on investments would create
a 95-point drop over time. 

The increase would cause a
drop of more than 900 points in the Dow over time, which closed at 10,497 on
Wednesday. 

The Barclays report states
the drop is because President Obama plans to increase taxes on the wealthy, who
are the country’s chief investors. This sector is likely to shift investment
strategies because of the coming tax increase. 

“[According] to the Fed’s
2007 Survey of Consumer Finances, 75 percent of stock market wealth is held by
families in the top percentile of income,” the Barclays’ report states. “From a
behavioral standpoint, if the government follows through on its plan to raise
dividend and capital gains taxes for the highest income earners, it could
influence the asset allocation decisions of an important investor class and
potentially bring about a shift away from equities, with negative knock-on
effects for the economy.”

Obama and Democratic leaders
have repeatedly stated their intent to raise taxes on individuals earning more
than $200,000 annually and couples making more than $250,000. This increase
also pertains to the taxes they pay on dividends and capital gains. 

Under the current plan, the
wealthy will pay a 20 percent tax on capital gains and up to 39.6 percent on
dividends beginning next year. 

However, Treasury Secretary Timothy Geithner has reportedly said
that the taxes on dividends should mirror that of capital gains, meaning that
both would be taxed at 20 percent beginning in 2011. To achieve that goal,
lawmakers will have to offset the cost differential between taxing dividends at
ordinary income tax rates and at 20 percent. 

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