How would candidates' tax plans affect investors?

[October 15, 2012]  WASHINGTON (AP) -- With the outcome of next month's presidential election increasingly hazy, here's a shred of clarity that investors can cling to: The tax rates they pay on investment income like stock profits and dividends are almost certain to change.

Whether rates rise or fall could affect the prices of some dividend-paying stocks, experts say. Some, mainly Republicans, believe that lower rates would boost the economy and lift markets.

Under the current system, people pay the government 15 percent on most dividends and capital gains, the profits from selling investments. Both candidates' proposals would divide taxpayers into two categories: Those who earn more than $200,000 per year -- $250,000 for families filing joint tax returns -- and those who earn less.

President Barack Obama would boost the rate on capital gains to 20 percent for higher earners and leave it at 15 percent for everyone else. Mitt Romney wants to maintain the 15 percent rate for wealthier people and eliminate the tax entirely for everyone else.

The differences are more dramatic when it comes to dividends. Obama would tax high earners' dividends as ordinary income, up to 39.6 percent for the wealthiest Americans. As with capital gains, Romney would maintain the 15 percent rate for richer people and eliminate the tax for people who make less.

The proposals reflect philosophical differences between the parties. Republicans think lower rates will encourage more people to invest, juicing the listless economy.

"It would encourage you to take more risks, put more capital into the economy and hopefully spur economic growth," says Taylor Griffin, who advises Republican campaigns and served in the Treasury Department under President George W. Bush.

Democrats say it's only fair that people who have succeeded in amassing wealth should pay a larger share of the nation's expenses. Higher rates did little to discourage investment during the 1990s, when Bill Clinton was in office and the economy boomed. During that period, Obama said last month while explaining his tax plan, "we created 23 million new jobs, the biggest surplus in history, and a whole lot of millionaires, to boot."

The election is not the final word on next year's tax rates. Both houses of Congress would have to approve any changes. Lawmakers have been deadlocked for years on taxes and spending, so any changes would likely be part of a broader bargain to postpone or avoid the so-called fiscal cliff at the end of 2012.

That's when automatic government spending cuts would take effect if lawmakers can't agree. In another blow, if no deal is reached, tax rates for everybody would return to the higher levels in effect before a series of cuts first passed during the Bush years.

Dividend rates for the highest earners would be almost three times as high, "a huge increase," says Raymond Radigan, managing director with U.S. Bank's wealth management division.

Retirees and others who rely on investment income, even if they're in lower tax brackets, could find dividend-paying stocks less attractive, says Adrian Day, whose Adrian Day Asset Management invests about $180 million for wealthy clients. To replace the lost income, they might buy riskier assets like junk bonds, Day says.

Yet raising the tax rate on dividends wouldn't necessarily hurt dividend stocks. Some companies might simply eliminate their dividends, says Cliff Caplan, a financial planner with Neponset Valley Financial Partners in Norwood, Mass.

Apple, for example, announced its first dividend in July, after running out of other uses for its colossal cash reserves. If the tax rate on dividends nearly triples, Caplan says, "I can see them saying, 'Screw it. Why pay it out when your investor is going to get killed on taxes?'"

If the universe of dividend stocks shrinks, people who need reliable income would rush into the remaining options. Those would include stocks like utilities, whose regulators sometimes require dividend payouts; and those that must pay out their profits to enjoy lower tax rates, like real estate investment trusts and some energy partnerships.

If many other companies stopped paying dividends, Caplan says, demand for utilities, REITs and energy partnerships could surge, boosting their share prices.

The proposed changes to capital gains rates are unlikely to have much effect on markets or on the economy, several experts said. Caplan calls that debate "a lot of hooting and hollering about nothing." Investment was strong when rates were much higher, before and during Ronald Reagan's presidency, says Caplan, who has managed money almost 35 years.

It's nearly impossible to plan for either possibility, experts say, because of the political uncertainty around tax policy. Day says that he and other investors are holding off on any tax-related buying and selling.

If it appeared likely that capital gains rates would rise to 20 percent from 15 percent, some people might sell stocks before the end of 2012 to take advantage of the lower rate. But that would only make sense only for people who are planning to sell an investment in the next 12 months, Day says, so the effect would be marginal.

The boost to 20 percent from 15 percent is "just not a huge enough jump," he says.

Eliminating investment taxes on people earning less than $200,000 a year would have little effect, experts agree, because those people tend to sock their available income in tax-protected retirement accounts.

As is the case with much of the campaign rhetoric so close to an election, Obama and Romney are playing up these differences to get voters' attention, said Daniel Alpert, managing partner at Westwood Capital LLC, a New York investment bank.

"The impact on the real economy of lifting capital gains taxes by 5 percent is about nil," Alpert says. For investors big enough to affect the financial system, he said, "The problem isn't that people aren't investing, or aren't incented to invest -- the problem is, there isn't a whole lot that actually warrants investment."

[Associated Press; By DANIEL WAGNER]

Daniel Wagner can be reached at http://twitter.com/wagnerreports.

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