Tax Rates and the Stock Market

There is an article (via Drudge Report) that says a failure to extend tax cuts, especially the capital gains rate, could lead to a stock market crash.  Basically, people would look to lock in gains at the lower capital gains tax rate.

This makes sense in a lot of ways.  If you sell a stock for a loss to try to claim the loss on your tax return and then you buy back the same stock, you could be subject to the wash-sale rule if you bought it back within a certain time frame.  I know of no such rule for selling winners.  That is because the government usually wants you to pay your tax and would rather you pay it now than later.  You almost have to wonder if congress comes up with some kind of penalty for selling a winning stock and then buying it back within a short time frame.

If I had a winning stock, I would sell it before the end of the year.  Why not pay the lower capital gains tax rate now than pay a higher one later?  And if you still want to own the stock, you could always sell it and buy it back.

This scenario is a real possibility.  The only question is how many people own winning stocks right now.  The market is about even over the last decade.  But still, there have been enough wild swings that there are definitely more than a handful of people that own winners right now.  There might be people who bought shares in March of 2009.  There might be people who bought 15 years ago that never sold.  There also might be people who bought individual stocks that have been winners (for example, Apple).

This could signal trouble for stocks that have had a big run lately.  A hike in the capital gains tax rate would give shareholders an incentive to sell before the end of the year.

While nothing is a guarantee (and that is always the case in investing), it might be an interesting time to speculate in shorting the market.  Before anything, I would lighten the load on stocks if you own any.  But you could also try speculating with a short ETF.  There are short ETFs for the major markets.  There are also double and even triple shorts for leverage.  Again, this would be a speculative play, but it might be worth a gamble with a small percentage of your money.