The Biggest Myth About Taxes

by: Lou Basenese

Forget Manic Mondays, we celebrate Myth-Busting Mondays. For the newbies in the group, each week I pick a widely held belief and use the Hammer of Truth to smash it into a billion little pieces. None have survived yet. But eventually, I expect to find a topic that can withstand the onslaught. If you know of any potential contenders, feel free to share them with me.

Right now, though, it's time to tackle a politically charged topic. (I know. The gall!) But if you think politics and finance don't mix, you're sorely mistaken. The overlap is undeniable. Policy in Washington directly impacts profits on Wall Street. I mean, did you see what happened to the markets during the whole "Fiscal Cliff" debate? And what about healthcare stocks during every jot and tittle of the healthcare reform debate?

Like I said, politics and finance do mix. With that in mind, let's dive right into dispelling the stubborn little myth that taxes don't influence behavior. Here's irrefutable proof that tax rates do, indeed, influence behavior. And lest you think I'm about to go on a tirade against taxing the rich, I'm going to start off by addressing the impact taxes have on everyday Americans…

Say "Hello" to the 2%

This has nothing to do with the Occupy Wall Street Movement (the 99% versus the 1%). I'm talking about the end to the 2% Social Security payroll tax holiday that occurred in January. Believe it or not, that little "extra" being taken out of everyone's paycheck is having a big impact. For instance, weekly retail sales data reveals deterioration in shopping activity in the New Year. Moreover, the latest Thomson Reuters/University of Michigan survey of consumer sentiment revealed that 32% of people with incomes below $75,000 reported a drop in pay.

"There is something going on," said Chris G. Christopher Jr., senior principal economist at IHS Global Insight. "The payroll tax seems to be cutting into things." You mean taxes are influencing behavior, Mr. Christopher? Say it isn't so! In all seriousness, economists estimate the payroll tax increase could reduce GDP growth by half a percentage point in the first quarter. And with an economy that's only expected to grow 1% to 2% in the first half of the year, every half a percentage point counts.

Give Me Lower Taxes… or Take My Passport

On the upper end of the income bracket, higher tax rates keep prompting well-known individuals to flee their home states and, in some cases, countries. France's richest man, Bernard Arnault, head of luxury goods company, LVMH (OTCPK:LVMHF), applied for a Belgian passport in the wake of his home country announcing a 75% tax rate on top earners. The list of other fleeing Frenchies includes Nicolas Sarkozy, Carla Bruni and Hollywood star, Gerard Depardieu.

In the sports world, Tiger Woods admitted that he fled California in 1996 because of tax rates. And his competitor, Phil Mickelson, confessed that he's considering fleeing, too. Why? Because California voters approved Proposition 30, which raises the state income tax on top earners to 13.3%. That's the highest in the land! Then there's U.S. pop music legend, Tina Turner. She handed over her U.S. passport to become a citizen of Switzerland. Granted, she's been living abroad since 1995. But the timing is awfully suspicious.

Individuals who aren't fleeing are exhibiting tax avoidance behavior, too. Consider: In New York, fourth-quarter home sales surged 29% to hit the highest level since 1987. The cause? "Buyers rushed to finish deals before expected tax increases this year," according to Bloomberg. Even "Mr. Green" himself, Al Gore, couldn't resist the temptation to pocket more green. Anonymous sources report he expedited a deal to sell Current TV to Al Jazeera to avoid higher tax rates.

Companies Hate Taxes, Too

To be fair, individuals aren't the only ones responding to tax rate changes. Corporations are, too. Consider:

  • Smith & Nephew (NYSE:SNN) fired roughly 100 employees this month, citing the new medical device tax that went into effect as part of The Patient Protection and Affordable Care Act.
  • San Diego-based company, Fallbrook Technologies, announced that it's relocating to Texas.
  • Wall Street's elite are packing up shop, too. According to the New York Post, private equity and hedge funds are relocating to Florida because of "New York's sky-high city and state tax rates."

Perhaps the broadest example of taxes influencing corporate behavior involves dividend payments. You'll recall, back in August 2012, I predicted the threat of higher dividend tax rates would bring about a special dividend payment bonanza. And it did. Special dividends hit a record $30.4 billion last year. Some companies, like Costco (NASDAQ:COST), even borrowed money to fund the early payouts.

Bottom line: At some point, taxation becomes excessive and definitely influences behavior. If you don't want to accept the most recent evidence, pick up a history book and get reacquainted with the motivations behind the American Revolutionary War. In fairness, I'd love to conduct a similar analysis on the impact of spending cuts on behavior. But Washington has been slow to volunteer for that experiment.

As far as the investment implications of today's myth-busting, they couldn't be more straightforward. We need to think twice before investing in any sectors in jeopardy of unexpected and significant increases in taxes. After all, the more the government gets, the less that's left over for investors. And less profits are never good for share prices.