What could spook this great bull market? Here’s a contrary thought: a capital gains tax cut. Sure it would be great news for investors. But putting aside all the questions of whether it’s a good idea, whether it’s fair, and so on, I want to contribute just one small idea to the ongoing debate: If you do cut it, cut it gradually.
Think about it. Say the capital gains rate were — bang — cut in half. Millions would have an immediate reason to sell; no one would have an immediate reason to buy. Don’t you own something you think is kind of toppy, but hate to sell because of taxes? Or even if you don’t, don’t you fear others do? Might a lot of them not want to sell — fast, before others do and drive down the price — as soon as the lower rate takes effect?
I could be wrong. Maybe no one would look at this sudden change in the rules of the game and want to take advantage of it . . . but when has that ever happened? Or maybe people would be so electrified by the prospect of lower tax rates they would rush to buy more shares. But I think the reaction on the buy side, while positive, would be much more relaxed. What’s the hurry? So you’d have an imbalance: more enthusiasm for selling than buying — and that drives prices down.
Happily, there’s a no-brainer solution. Just phase in the cut gradually. E.g., cut the 28% top rate 2% a year for seven years. Selling would be spread out. (It might peak a little in January of each year, as each new tax cut notched in; but that’s a good month to absorb extra selling, because it already has a bias toward extra buying because of inflows from bonus money and the like.) Some would wait all seven years. Others would grab the 2% right now, now that there’s no longer any prospect of a large immediate tax break. Many would do something in between. Yes, there would be a bit of a bias toward holding on . . . but what’s so bad about that?
So if you DO cut it — and I’m not at all sure we need a drastic cut in the capital gains rate right now, much as I’d enjoy one — cut it gradually. (How about cutting it 1% for eight years, bringing the top rate down from 28% to 20%?)
And while I’ve been writing this mainly in terms of the stock market, don’t think there wouldn’t be an impact on the real estate market, as well — especially investment real estate. A homeowner who sells is generally, though not always, more or less simultaneously a buyer as well. And homeowners already enjoy enormous shelter from capital gains taxes. But with investment real estate, most of which (because of depreciation) sits with large unrealized capital gains, a chance to cash out at 14% instead of 28% might trigger a lot more FOR SALE signs than “Investment Properties Sought” classifieds . . . and thus depress prices.
Because remember: no one says you have to take the cash you get for selling a stock or office building and immediately reinvest it. Yes, you become a potential buyer. But what if instead of immediately buying some different stock or office building, you use the cash to pay down debt? Or to buy municipal bonds? Or to resurface your driveway?
So guys: whatever you do, do it gradually. If not, we may see prices decline even before the tax cut takes effect. (Wouldn’t a lot of people/institutions with money in tax-sheltered accounts, fearing selling when the sharp break in tax rates becomes effective, want to take the precaution of selling first?)
Not a bad time to be a stockbroker, or a real estate broker, though, if the tax barriers to selling are suddenly cut in half. And almost as good a time if the barriers are cut gradually.