Anticipated end-of-year tax increases, though bad for the economy, will be a positive for life insurance and financial service professionals advising clients on tax avoidance strategies.
So noted a team of experts with Toronto-based BMO Financial Group, which hosted a conference call on Wednesday for journalists to explore the implications of President Obama’s election victory on Tuesday.
“Tax avoidance will return as an investment strategy, with less productive uses of capital,” said Andrew Busch, a Chicago-based global currency and public policy strategist at BMO Capital Markets. “When you tell upper income earners that you’re going to raise their taxes to 39.6% from 35% and raise taxes on capital formation and investment, then people will adopt strategies to avoid paying taxes.”
Jack Ablin, chief investment officer of BMO Private Bank, agreed.
“To the extent that life insurance plays a critical role in tax avoidance strategies for estate tax and other tax-related issues, [President’s Obama's victory] could present a much bigger opportunity and expanding role of life insurance,” he said. “Between life insurance and municipal bonds, it would seem those would be favorably impacted by the election results.”
Busch warned that investor concerns about the approach of the fiscal cliff—the combination of expiring tax cuts and across-the-board government spending cuts which, scheduled to become effective Dec. 31, 2012, threatens to send the economy back into a recession—could prompt credit rating agencies Fitch and Moody’s to warn that, absent Congressional action, they intend to downgrade U.S. debt. But the end-of-year tax deadlines, he noted, could also work to the Democrats’ advantage.
“The Democrats see a clear advantage to going over the cliff,” he said. “In January, once the Bush tax cuts have expired, Democrats would be free to draft their own plan to cut taxes for the middle class and not the wealthy—and to dare Republicans to reject their plan.
“That could be a viable strategy for most Democrats going into the lame duck session and into 2013,” he added. “But I would imagine the ratings agencies would not be pleased with this strategy.”
Busch noted that a return to the pre-2001 tax regime, which BMO expects, would have a generally negative effect on the economy. In addition to the dividends tax rate (which he foresees rising to 43.4%), he noted that the capital gains tax should rise to 23.8% from the current 15%; that the U.S. will likely add to its extra-territorial 35% tax on overseas investments with a new minimum tax on corporations; and that the estate tax will rise to 55% from 35%.
“We should see tremendous portfolio churn—a switch from dividend-paying stocks to growth stocks,” Busch said. “As an investor, if you’re going to get taxed at almost 44%, why would you want to own dividend-paying stocks?
“I anticipate that technology companies will not pay dividends going forward or they will reduce them due to the tax increase,” he added.
Paul Taylor, chief investment officer, fundamental equities of BMO Asset Management Inc., said the anticipated higher corporate tax rates and stock market performance in 2013 dictates moving investments to stocks that are trading at a discount to U.S. shares. Among them: those of the BRIC nations: Brazil, Russia, India and China. He cautioned, however, that the performance of BRIC shares will hinge in part on the implementation of monetary and fiscal stimulus policies that will induce growth in the BRIC economies.
To the extent that investors remain in U.S. stocks, said Ablin, then technology shares are a good bet because this sector is lightly regulated and growing. Given also the administration’s position on a dividends tax— President Obama’s 2013 budget proposes bringing tax rates for dividends up to those for ordinary income, which would result in a tax rate of about 40% for the highest-income groups—technology shares will, among the sectors, “likely be least impacted by any policy change.”
Busch noted that insurance companies, hospitals, makers of generic pharmaceuticals are “winners” under the Affordable Care Act because of the expected increase in sales for these companies. Other companies that stand to benefit from the administration’s policies include makers of biofuels and autos.