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A Taxing Stock Market Sell-Off
In November, remember who deserves the blame.


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Larry Kudlow

Though the mainstream media are not reporting it, one of the key elements of last week’s stock market downturn was tax-payment-date selling of stock-market shares. This wasn’t the only factor in the correction, but it was an important one.

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Probably starting in March, when investors were told of all of their 1999 tax records, tax sticker-shock probably started to set in. By the way, this is just about the time that the NASDAQ market slide began – even before Joel Klein’s anti-trust assault on Microsoft reached a new level.

Back to tax sticker-shock. In the fourth quarter of 1999, the NASDAQ high-tech index registered a spectacular rise. Surely investors were well aware of this. But they may not have realized the extent to which mutual funds and hedge funds — which are private partnerships or shareholder associations — would pass on these capital gains to their investors. K-1 forms, which are sort of the W-2 tax forms for hedge funds and other partnerships, would have been arriving in the mail about the middle of March. Some of the capital gains could be taken at the long-term 20% rate, but many of them would be declared at the short-term 40% rate. So, a few weeks ago, investors came to realize for the first time that last year’s strong market performance requires a humongously bigger tax payment. This is what I mean by tax sticker-shock.

Then there’s a second tax issue. A lot of Americans made much more money last year than ever before. Bonuses, for example, were undoubtedly much bigger, along with accelerated salary increases. Now, the standard withholding rate is 28% for all wage- and salary-related income. But many, many people in the top 10% of earners were faced with a 40% marginal rate on the non-withheld income that came in above the 28% bracket. So the 12 percentage-point difference — between 28% and 40% — covered a lot more dollars than many people anticipated.

It’s one thing to know you’re doing well, but it’s quite another to receive a tax document that shows how much more you owe because you’re doing well. A 12% spread, along with higher capital gains, may well have induced a lot more stock-selling in order to meet tax payments due April 15 than the majority of high earners anticipated.

Several veteran tax-accountant friends of mine reported a huge volume of tax-related stock-selling last week. That would not have accounted for Friday’s market debacle, but it surely had an impact on the Tuesday-Wednesday-Thursday sell-off.

Cashiers at the major brokerage firms were overwhelmed with check requests from customers. It’s impossible to quantify this, but surely it was an important factor – not only in terms of the physical liquidations, but also in terms of the psychological effects that permeated the New York brokerage community last week.

This is a short-term, temporary problem that has now run its course. But it just goes to show how important tax policy can be. Early estimates for fiscal year 2000 (based on 1999’s economic performance) suggest that individual tax collections could be rising at a record 12% rate. The top 10% of American taxpayers pay roughly 49% of income-tax collections. This undoubtedly encompasses a large chunk of shareholders who will probably remember last week’s tax-overpayment episode come this November’s election.

Overflowing tax revenues could yield a $230 billion budget surplus that may include a $65 billion on-budget (non-Social Security) surplus. The Republican Congress should be pledging to turn this tax surplus back to the people who earned it in the first place. In this way, Clinton-Gore opposition to broad-based tax cutting can be linked to the stock market sell-off, and punctuated with some hard numbers on the record overcharging of taxpayers.

To be sure, Joel Klein’s thinly veiled attack on big technology companies, along with Alan Greenspan’s overly tight monetary policies, are playing a big role in this spring’s stock market drop-off. Call it the Klein-Greenspan bear market. But taxes also matter.



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