US Dividend Tax Policy Drives Economic Growth and Growth Investing Strategies
America Leads the Failed Attack on Private Capital Formation
As America addresses its Fiscal Cliff, savers and private capital formation will be punished. Dividend Tax will rise to fifty per cent in 2013; and Capital Gains Tax will rise from fifteen to twenty five per cent. America will thus have the highest taxes on private capital in the developed world.
The immediate conclusion to be drawn is that wealth is being confiscated; along with all hopes of the private sector ever becoming the driver of growth that it once was. In the absence of private capital formation, all growth will be created by the Federal Government. Unfortunately however, since the Federal Government is also cutting its debts and expenditures, there is no growth to be expected from here either.
It therefore looks as though the American economy is headed for a period of continued economic stagnation. This pessimistic conclusion overlooks the resourcefulness and creativity of the American private sector.
A high tax on dividends therefore means that earnings will be retained and put to some more fiscally advantageous use for investors. Retained earnings could be used for share buybacks. Alternatively, they could be used to acquire other companies. They could also be used for internal growth; through the application of productivity gains on capital investment. Better still, they could be used to pay down debt and make the balance sheet impregnable.
All these strategies, for the use of retained earnings, have the impact of reducing the size of shares and debt outstanding relative to company earnings. American corporate balance sheets are going to become the strongest in the world; which will command a re-rating by the global capital markets. American Price/Earnings multiples will therefore expand as the markets revalue these company strategies with premium ratings. Growth strategies and spurious growth strategies through mergers and productivity growth will therefore command share price premium valuations.
Since Capital Gains Tax is lower than Dividend Tax, companies and investors will be driven into strategies that reflect this fiscal arbitrage. Policy makers will then take credit for creating a pro-growth fiscal background; and the booming equity market that follows. Employment will then be created in the sectors, such as financial services, that benefit from these fiscal behavioural incentives. For example, unemployed real estate brokers will become stock brokers.
The commitment of the Federal Reserve to keep interest rates low until 2015 and Quantitative Easing in place until some definable growth target is reached, can only add to this pro-growth investing climate. The liquidity provided by the Fed is the fuel and the tax policy is the catalyst to drive a rally in equity prices; that will continue to confound most investors. Most investors perceive weak growth and the confiscation of capital through taxes as a headwind for equities. Those who understand company behaviour, will see the current depressed equity valuations as the source of future capital gains.