Capital Gains Taxes Are Likely To Fall
by Dr. Richard S. Appel
December 03/04
One of the cornerstones of President Bush’s earlier and much debated
tax cuts, was the substantial tax reduction on long term capital gains.
These were reduced to a maximum of 15% from their 20% level in recent
years, which in turn replaced the 28% rate that had long been a mainstay
of our tax code.
In general, everything owned for personal or investment purposes is considered
a capital asset. Capital gains profits or losses accrue from the sale
of items within these categories. They can be in real estate, in art,
in stocks and bonds, in collectibles or in a myriad of other asset classes.
Most nations treat capital gains in a more favorable fashion than they
do ordinary income. This is income that is derived from employment or
the participation in some enterprise. The primary reason why many governments
bestow lowered tax burdens upon capital items is because investments in
a number of these segments can directly and positively influence a country’s
economic health.
The advancement of a nation state is largely fostered through the development
and growth of its various industries. Since the acquisition of capital
is among the primary requirements needed to stimulate this occurrence,
companies of all sizes must be able to readily access capital in order
to succeed. They may use the acquired funds to build or refurbish their
factories, add to their inventories, for acquisitions or the purchase
of new equipment, for the research and development of new ideas, to increase
their workforce, or for numerous other reasons. It is the general increase
in business generated from the wise use of capital that is responsible
for the economic growth of an entire people. One can liken the rain that
nurtures a seed and allows it to sprout, to the capital needed by a business
that is necessary to enable it to grow.
Governments that stifle public investment in the business sector tend
to produce stagnant or moderate growth for their nation. This can be best
witnessed in the general low growth rates of socialistic or communistic
governed societies. Conversely, if a country’s government encourages
its citizenry to provide working capital to its enterprises, they will
give their economy the greatest opportunity to flourish.
When a nation’s citizens have the ability to benefit from successfully
investing in an area offering limited taxation, they will tend to migrate
towards it. To my mind this is quite natural because it reflects the desire
of all individuals to do what is in their own best self interest. This
in fact is one of the primary reasons behind the inception of and the
ongoing nationwide U.S. housing market boom.
The U.S. Tax Code governing the taxation of primary dwellings was changed
in mid-1997. This resulted in the elimination of personal capital gains
obligations on the initial profit on residences, when an individual or
a couple sold their home. The first $250,000 in capital gains for a single
person and $500,000 for a married couple became exempt from any and all
federal taxes. Other than in a few areas prior to that announcement, the
U.S. housing market was rather lackluster.
When people realized that they could actually not only enjoy owning a
home but could profit from its price appreciation, the movement from apartment
life towards home ownership ensued. In fact, this exodus escalated as
the housing boom unfolded. Further, purchasing a second home became more
prevalent throughout our nation. An additional dwelling was looked upon
as another vehicle from which to profit in the rising real estate market.
In essence people could have their cake and eat it too, without being
burdened with the capital gains tax liability that accompanied most other
investments.
The only requirements that investors had to satisfy was that their homes
had to be the primary residence of an individual, or at minimum one spouse,
for at least two of the prior five years. This was relatively easy to
achieve even if a single person or couple had two dwellings. They could
live in one home for two years while renting the other. When they sold
the first abode and pocked their tax-free profit, they could move into
their other one for the following two years, and would again qualify for
the favorable tax exemption.
The reason why I believe that we will likely be favored with further reduced
capital gains taxes in the not too distant future is due to our government’s
desire to stimulate our nation’s economy. There are a number of
leading indicators and anecdotal evidence that suggest that our economy
is expanding, albeit it at a reduced pace. However, there are just as
many others that lead me to believe that our nation may be poised to again
enter a period of economic turmoil which has the potential to be quite
severe.
The U.S. dollar as viewed through the action of the U.S. Dollar Index
began its present decline from its120 peak in early 2002, and yesterday
breached 82. This is an incredible 31% parity fall in the space of only
two and one half years. In fact, it fell to a greater degree against numerous
currencies such as the euro. Yet, not only did the significance of this
amazing, broad collapse go virtually unnoticed until recently by the media,
but it’s expected effect has done little to stimulate our economy.
Foreigners make decisions to acquire our goods and services based upon
the cost of our items in their own currencies. Something that cost 100
euros when the dollar was trading at $0.83 per euro declined to about
62 euros given today’s euro vs. dollar exchange rate. A euro is
presently worth about $1.33. Normally, even a far smaller increase in
the euro’s purchasing power vis a vis the dollar would have caused
a rush of euro zone purchases of American goods and services. However,
given the great competition and lower prices offered by the various Asian
countries, a significant desire to acquire dollar denominated goods has
not yet materialized. Additionally, the ability of most European Economic
Community countries to purchase foreign goods has fallen. This is due
to the weakening economies suffered by many of their members.
Despite the regular official commentary that the U.S. economy is doing
well, I believe that great doubt pervades our administration and Federal
Reserve about its true state and its future. During the past few years
we have experienced rock bottom interest rates and an unprecedented high
level of monetary stimulation. Further, the cost of many goods sold in
America have stagnated or declined. Additionally, taxes have been lowered
during the same period. The combination of these occurrences in the past
would have generated a significant jolt to our country’s economic
performance. Yet, despite all of the fiscal and monetary machinations
that have been implemented, the economy has been able to do little better
than hold its own.
Our government and Fed officials recognize that confidence in the future
of the economy is weakening and that any economic or financial misstep
has the potential to frighten consumers into reducing their purchases.
If such an event transpires it has the likelihood of effectively knocking
the legs out from under our already fragile economy. A sharp decline in
stock or housing prices, rapidly rising interest rates, a significant
reduction in foreign purchases of U.S. goods, or some other surprise are
all that is needed to trigger such an event.
The reason for President Bush’s desire to reduce capital gains taxes
during his first term of office was to stimulate the economy. Now, he
realizes that all of his and the Federal Reserve’s efforts have
been insufficient to jump start a concrete economic recovery, and have
only acted to forestall a recession.
Recognizing the tenuous state of our business sector and now that he can
again focus on the economy, I believe that President Bush will quickly
act to introduce and push through legislation that will further lower
U.S. capital gains taxes. This will alter the actions of investors in
a number of important ways, and will have the potential to positively
impact our economy. First, it will place more money in the hands of our
citizenry. They will either spend it, which will help stimulate the economy
through their purchases, or they will save it. The latter will increase
the capital pool available to businesses and will also help improve their
lot. Next, it will entice investors to either maintain or increase their
investments in common stocks. This may help support stock prices at their
current levels, or at least hopefully soften any approaching broad stock
market decline. Further, it will promote greater availability of capital
to our nation’s companies. With a similar result as I described
above caused by the elimination of capital gains on housing, I believe
that investors will act upon the reduced tax incentives and offer an increased
amount of venture capital to our country’s businesses. This will
enhance their prospects and thereby add impetus to the growth of our economy.
President Bush’s initial capital gains reductions only affected
long-term capital gains. Short term gains which are investments held for
less than one year and a day, remained taxed as ordinary income. When
the holding period for long-term capital gains treatment was increased
from six months and one day to its present duration a few years ago, it
appeared obvious that it was motivated by the government desired to keep
investors holding onto their common stocks. I believe that this ploy has
outlived its usefulness. Further, if our officials continue to treat short
and long-term gains differently, I believe that they will be missing a
major opportunity to enhance any long-term rate reductions that they might
institute. By reducing and treating both long and short-term capital gains
similarly, with little or no hold period separating the two, they will
likely free up an avalanche of money flowing into the U.S. investment
arena. It worked in the housing market and I am confident that it will
also benefit the economy and stock markets.
Given the tenuous nature of our economic and financial systems, combined
with President Bush’s well known desire to use capital gains tax
reductions to solve this looming problem, I believe that it is highly
likely that the new year will bring with it favorable capital gains tax
changes that will benefit us all. For these reasons, I believe that it
is now prudent to undertake all investment decisions with that potential
in mind.
The above was excerpted from the December 2004 issue of Financial Insights © November 28, 2004.
I publish Financial Insights. It is a monthly newsletter in which I discuss gold, the financial markets, as well as various junior resource stocks that I believe offer great price appreciation potential.
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CAVEAT
I expect to have positions in many of the stocks that I discuss in these
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avoid those that I own! I will attempt wherever possible, to offer stocks
that I believe will allow my subscribers to participate without unduly
affecting the stock price. It is my desire for my subscribers to purchase
their stock as cheaply as possible. I would also suggest to beginning
purchasers of these stocks, the following: always place limit orders when
making purchases. If you don't, you run the risk of paying too much because
you may inadvertently and unnecessarily raise the price. It may take a
little patience, but in the long run you will save yourself a significant
sum of money. In order to have a chance for success in this market, you
must spread your risk among several companies. To that end, you should
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speculations! Never invest any money in these stocks that you could not
afford to lose all of.
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