Investor calls reaction to tax plan overwrought

As anxious investors assess their portfolios in light of expected tax increases on investment income, hedge fund manager Douglas Kass has a simple message: Relax.

Kass, founder of Seabreeze Partners Management, thinks the investing world has overestimated how hard markets and investors would be hit if tax rates on dividends and capital gains rise at the end of the year, as the White House has proposed.

Kass can look for support to several economists who have studied past changes in tax rates and found the shifts had less of an impact on investor behavior than expected.


That’s largely because a dwindling number of investors are subject to the taxes on investment gains that are set to rise at the end of the year, with most stocks held in accounts that are exempt from taxes.

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For example, only 14.7 percent of households have mutual funds in taxable accounts, down from as high as 23.9 percent in 2001, according to the Investment Company Institute.

Douglas A. Shackelford, an economist who examined 2003 legislation that lowered tax rates on capital gains and dividends, said that ‘‘people thought this would be revolutionary,’’ sparking changes in the way companies rewarded investors, and how investors evaluated companies.

In the end, ‘‘it made a difference, but it certainly was not revolutionary,’’ said Shackelford, a University of North Carolina professor.

While data on the tax status of all stockholders is hard to come by, many economists agree an increasing proportion of the entire equities market is now held by retirement investors whose holdings are not subject to current tax law, by foreign investors who don’t pay American taxes, or by institutional investors like insurance companies and pension funds that are exempt from taxes.


Sam Stovall, chief investment strategist at S&P Capital IQ, said that even among individuals who do pay the taxes, many have incomes under $250,000 and would not be subject to the increased rates proposed by the White House.

Stovall and others are not discounting the potential disruption to the financial markets if the White House and Congress fail to reach any agreement on the broad set of tax increases and spending cuts scheduled to hit Jan. 1.

The largest are not on investment income, however. An increase in the payroll tax, for example, could remove $95 billion from the take-home pay of Americans.

But even with a broad agreement, many strategists are expecting that taxes will rise on investment income, with the White House proposing that for households earning more than $250,000 the rate on dividends rise to a peak of 39.6 percent from the current 15 percent, and the rate on capital gains increasing to 20 percent from 15 percent.

Wealthy households would face an additional 3.8 percent charge on most investment income to help pay for the recent health care legislation.