Delaying Tax Vote Could Crash Stock Market

Failure by Congress to extend the Bush tax cuts, especially locking in the 15 percent capital gains tax rate, will spark a stock market sell off starting December 15 as investors move to lock in gains at a lower rate than the 20 percent it would jump to next year, warn analysts. [See who gets the most money from the financial industry.]

While it is unclear how bad the sell off could be, it could wipe out the year's gains, they warn.

"Capital gains tax rate will increase from 15 to 20 percent if the tax cuts are not extended. The last time the capital gains tax rate increased--on Jan. 1, 1987 from 20 to 28 percent--investors realized their gains at the lower tax rate," said Daniel Clifton at a Washington partner at Strategas Research Partners. "We would expect a similar effect this time around as investors see the tax rate going up and choose to realize their gains and incur the 15 percent tax." [See a gallery of political caricatures.]

In a memo to clients, Clifton says that the date most clients are focused on is December 15th for a deal in Congress before beginning to sell. One reason: Many stock options expire that day and investors have to act.

The later Congress acts, he tells Whispers, "the more pressure that will build on the stock market."

Worse, talk that Congress will simply pass retroactive fixes to the tax system won't help, since investors will take the sure thing and sell rather than rely on Capitol Hill. "Fixing the issue next year will not negate these negative impacts," said Clifton. [See a slide show of 10 not so recession proof industries.]

Ditto for a retroactive fix to the alternative minimum tax, he writes in the client memo. "The talk of retroactively fixing the tax cuts ignores the fact that the AMT patch cannot be retroactively fixed and is the largest component of the tax increase. Hence, in March and April, 27 million taxpayers will be facing an additional $70 billion in tax payments. The hit to consumer spending would be particularly significant," he writes.

See his full memo here.

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