As ETF investors wonder who will win the presidential election, taxes loom largely.
U.S. voters head to the polls on Tuesday in a presidential election between two candidates with starkly different views on a variety of issues. That matters to ETF investors, because the outcome of the election could have a direct impact on investment returns.
One issue that comes to mind is the future of tax rates. Much has been said about President Barack Obama’s “Obamacare,” a piece of legislation that promises to shake up health care premiums and the bottom lines of insurance companies, but more importantly to ETF investors, it could have major tax implications on investment income.
IndexUniverse Analyst Carolyn Hill earlier this year outlined just how much higher taxes on things like dividends, interest, and short- and long-term capital gains could be if Obamacare does indeed get rubber-stamped. For the record, Republican-party candidate Mitt Romney has said that if elected, he will overturn this legislation.
Taxes would be going up by 3.8 percentage points on all joint filers with adjusted gross income of more than $250,000, and on single filers with incomes over $200,000—changes that would take effect a full year before the health law is scheduled to kick in, Hill said in her blog back in July.
“This additional tax could potentially have a significant impact on all the dividend-focused ETFs that have been so popular lately,” Hill said. “A 3.8 percentage point tax hike may not seem like a big deal until you consider it in the context of tax rates as they currently stand—and what they could rise to if the Bush-era tax cuts aren’t extended.”
Indeed, dividends are currently taxed at 15 percent, but could be taxed at 18.8 percent next year, and if Bush-era tax cuts aren’t extended, those rates could soar to 43.4 percent, while taxes on long-term capital gains would rise to 23.8 percent, Hill said.
More broadly, there’s a tacit understanding that taxes are probably heading higher, even if that’s not what either former Massachusetts Governor Romney or President Obama are saying.
“Everyone believes that taxes on long-term capital gains will not stay as low as they are in 2012, regardless of who takes office,” ConvergEx Group Chief Market Strategist Nicholas Colas told IndexUniverse. “We have a big deficit to fill and a 15 percent tax rate will not do.”
That reality, Colas stressed, will remain true no matter who takes office in 2013, so bracing for higher taxes on capital gains is pretty much a given.
And while most of the market’s attention right now is being paid to the election itself, Colas said advisors are busy alerting their clients to the implications of a higher tax rate.
Growing outflows from mutual funds, particularly in equities, are an indication that many investors are taking to heart the message that they should be “selling” some of those capital gains incurred over the years before the end of 2012, Colas said.