The so-called fiscal cliff has been cited repeatedly for the reason stocks are falling behind, but another important factor that has investors worried is the potential increase in capital gains taxes. These taxes reduce the total profit to be made from investing and therefore makes owning stocks less attractive. As a result, investors begin to sell off stocks, such as a dividend paying shares, which are worth less if capital gains tax goes up, and this sell-off can trigger a fall in the stock market. On the bright side, government and municipal bonds will become more attractive because these are mostly exempt from capital gains taxes.
However, a counter argument to this is that Obama plans to increase capital gains taxes from 15 percent to 20 percent for high earners only. So this increase might not even affect some people at all. The rate is going to continue to be zero percent for people below the 10 and 15 percent tax brackets.
Also, the rise in capital gains taxes can have a multiplier effect and cause the stock market to sag even more because investors now expect the economy to slow down as these taxes discourage investment (that is, the first effect is to discourage investment which causes another round of falling stock prices).
However, the idea that capital gains taxes have an adverse effect on growth may not be entirely true, according to this article which cites several studies and academic papers pointing to the lack of correlation between capital gains taxes and economic growth. It concludes that if people believe the economy will not slow down and do not react as drastically to the rise in capital gains taxes, the overall effect on the stock market would probably be much smaller.
NYU Professor and Economist Nouriel Roubini delineated a number of other factors besides the fiscal cliff which he thinks are responsible for sliding stock prices. The euro crisis is apparently not over yet, and is getting worse after signs of some recovery. What is more, Roubini claims that the crisis is now spreading from the periphery to the core of the eurozone. The “core” economies are the strongest ones and if they enter a recession, it is definitely not good news for stock markets.
Written by Fay Faatin.