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Sell, It’s The Democrats!

The Party of Roosevelt is talking a lot about taxes these days, about fairness and about how fat-cat hedge fund managers pay taxes at lower rates than school teachers (which, unless the fat cats are grossing most of their money on dividends, can't be true). Frankly, tax justice talk may seem downright scary to investors and the high-net-worth set. But while the glorious years of the Bush tax cuts

Party of Roosevelt is talking a lot about taxes these days, about fairness and about how fat-cat hedge fund managers pay taxes at lower rates than school teachers (which, unless the fat cats are grossing most of their money on dividends, can't be true). Frankly, “tax justice” talk may seem downright scary to investors and the high-net-worth set. But while the glorious years of the Bush tax cuts are likely to end during the next term, does a Democratically-controlled government mean the rich are going to hemorrhage cash?

“There is a fairly high probability that some of the tax rates will go up if we end up with a Democratic president,” says David Canon, professor of political science at the University of Wisconsin at Madison.

But experts say that the tax hikes may not be as bad as John Edwards' rhetoric would suggest. Indeed, as this issue goes to press in late August, Americans are getting the full-court populist press from the Democrats, who see a lame duck George W. Bush as an opportunity to speak confidently to their base, says Greg Valliere, chief strategist at the Stanford Washington Research Group. The growth of a supposed income gap between rich and poor has been a prominent theme thus far. And so, while the lowest tax period since World War II surely helped the country's economic success over the last six years, expensive military adventures and the looming liabilities of Medicare, Medicaid and Social Security need to be paid for somehow, Democrats say. While the Democrats frequently complain about soaring budget deficits, the U.S. deficit is set to fall below $150 billion by the government's fiscal year end in September, says David Malpass, chief economist at Bear Stearns. Both parties do agree that a crisis may be on the horizon; but how to go about correcting the situation is where they diverge.

Tax the Fat Cats

Wall Street's success in the past several years — again, owing in part to historically low taxes — has made The Street an easy target for the Democrats' revenue-generating ideas. Most recently, Congress began mulling the tax treatment of public offerings by high-flying private equity firms, as well as their profits and the profits of hedge funds. Despite Sen. Charles Schumer's pledges to stop any such measures, increases to the tax structures of these entities could be on the books before the next president is elected.

Then there's the $1.35 trillion in tax cuts that Bush got passed in 2001 and 2003; these are set to expire beginning in 2009 unless Congress extends them. But the Democratic majority has already said they won't extend the Bush tax cuts, at least not in their entirety. That leaves huge question marks looming over several tax rates, including capital gains (which will rise to 20 percent on Jan. 1, 2009) and qualified dividends (which will be taxed at ordinary income tax rates on Jan. 1, 2009), and the estate tax (which, by the way, only 2 percent of Americans actually pay). But as more than one political sage has said, proposing change (especially to the public on the campaign trail), and actually passing the proposals through both houses of Congress as advertised are two different things. Will the Democrats hammer the rich if elected? Not likely. Well, perhaps a little. But you and your clients could definitely be in for reduced take-home pay, less investment income and, in general, increased tax burdens down the road — no matter who is in the Oval Office.

While the individual investor may have some idea where he'll stand depending on who is elected, it's still too early to know exactly what the Democratic Congress (and many of the presidential hopefuls) can pull off. “Congress did not articulate a financial-service agenda,” says Scott Defife, the new co-head of government relations for the Securities Industry and Financial Markets Association (SIFMA). “The industry is still trying to assess what the Democratic majority's end goals are,” he says.

That said, Defife, who is the former senior policy advisor to House Majority Leader Steny Hoyer (D-Md.), says early signs from the Democratic Congress are good, among them its willingness to investigate problems via its oversight role instead of creating new regulation out-of-hand. As for SIFMA's agenda, Defife says the group will be watching any tax reform discussions and the eventual sunset of Bush's tax cuts, including the expiration of favorable rates for capital gains and qualified dividends. “We've been discussing it with members. [We want] to hear what they want out of 2009 and 2010, but we're not there yet,” he says.

Think Like It's 2009

Of course, some of the industry's most prominent firms are already making bets on the 2008 presidential horse race. And so far the firms are leaning Democratic with their contributions (see chart above). They're undoubtedly hedging their bets, says Canon.

Chris Shorba, an estate-and tax-planning partner with Kern DeWenter Viere in St. Cloud, Minn., says he's already advised clients to think like it's 2009. “We've been telling clients for two years to take some capital gains off the table,” he says, anticipating that the rate will go up to at least 20 percent; that rate increase is scheduled to take effect on Jan. 1, 2009, unless Congress acts. Shorba says deferring taxes on real estate may be a bad idea too. “Why do another 1031 exchange when all you're doing is deferring paying taxes to a later year when the rate will likely be much higher,” he asks. And if clients are shredding their nerves envisioning socialist-like Democrats taxing the heck out of them, Shorba gives them a point of reference: “The top tax bracket was 70 percent in 1980. It was 92 percent in 1962. People don't remember that, so 35 to 40 percent is a bargain, really.”

What scares some investors is John Edwards' July proposal to raise the capital gains rate to 28 percent for those with incomes of more than $250,000; then there is Rep. Richard Neal's (D-Mass.) June proposal to exact a 4.3 percent surcharge tax on adjusted gross income of $500,000 or more. That would bring the top marginal tax rate to 39.3 percent. Gerald Prante, an economist with the Tax Foundation, a non-partisan think tank in Washington, D.C., says what's driving the tax talk is simple: “Basically, there are new spending initiatives that need to be paid for somehow.” Those include: health care reform (some want government-run, universal coverage), unfunded liabilities like Medicare, Medicaid and Social Security, as well as perennial concerns, such as education and the budget deficit.

Then there's the dreaded Alternative Minimum Tax (AMT). Neither party says it likes the AMT, yet neither party wants it to go away entirely either — well, not yet anyway. Designed more than three decades ago to impose a tax on high-income individuals who were sneaking around the regular income tax code, the AMT currently affects roughly 3 million Americans. If Congress doesn't act, that number will rise to 29 million by 2010, according to the Congressional Budget Office. One in five taxpayers will have AMT liability by 2010, including nearly every married couple earning between $100,000 and $500,000 — hardly the filthy-rich tax dodgers it was originally intended for. It was called “the most serious problem faced by taxpayers” by an IRS official in a report to Congress in 2003. For this reason, Prante, like many political analysts and economists, sees the two parties compromising in the form of another one or two-year patch for the AMT. But that's another short-term fix that will also create yet another revenue shortfall — $600 billion over the next decade, according to the CBO. Since the AMT generates billions in revenue for the federal government, that revenue will need to be replaced. (What? Cut government spending? Yeah, right.) The capital-gains tax and Rep. Neal's surcharge tax are possible sources of income for that purpose. Unfortunately, simplifying the tax code, which is more than 9 million words long — seven times longer than the Bible — is not on the Congressional agenda, says Prante.

But what Prante and many others point out is that despite the sunsetting on many of Bush's tax cuts between 2009 and 2011, any attempts by the Democrats to enact legislation that would significantly alter the tax landscape would fail. That's because even if the Democrats control the White House and Congress, the House and the Senate must agree on a version of a bill for it to become law. And in the Senate, where a bill needs 60 votes to pass, parties must play nice in order to sway 10 members of the opposing party. House legislation that is more controversial often gets dampened this way. (“George Washington said, ‘The Senate is the saucer that cools the hot tea of the House,’” says Canon, the political science professor from the University of Wisconsin.)

Mark Braswell, an attorney with Thalman Reid, who has lobbied Congress on behalf of financial services clients, also says the Senate's agreeable nature bodes well for the industry. “The Senate Banking Committee, which has jurisdiction over the securities industry, is a very cordial committee,” he says. “Senators Shelby (R-Ala.) and Dodd (D-Conn.) work with each other, so no one will be pushing through their own legislation.” For example, he expects Dodd won't rubberstamp any tax-hike proposals relating to hedge funds and private equity firms, which represent an influential part of his constituency. Sen. Schumer, a colleague of Dodd's on the Banking Committee, came out early against any new tax hikes for hedge funds and private equity firms. It's powerful moderate Democrats like Schumer (well, on this issue at least) who may be a foil to Democratic presidential hopefuls like Hillary Clinton, who has said she'd let Bush's tax cuts expire, and would favor tweaking the tax treatment of hedge funds and private equity firms. “Major changes to capital gains, for instance, would be tough because there are quite a few Democrats, prominent ones like Schumer, who would be less likely to go along with it,” says Canon.

Hiding Their Bets

Contributions from the securities and investment industry to presidential hopefuls are spread around to both parties.

Hillary Clinton (D): $3.3 million

Barack Obama (D): $3.2 million

Rudy Giuliani (R): $3 million

Mitt Romney (R): $2.9 million

Christopher Dodd (D): $2.2 million

Source: The Center for Responsive Politics,

Efforts to Influence?

Hedge funds and private equity firms have been contributing to those who would increase taxes on them.

Mitt Romney (R): $797,325

Christopher Dodd (D): $726,950

Hillary Clinton (D): $703,600

Barack Obama (D): $652,105

Rudolph Giuliani (R): $644,750

Source: The Center for Responsive Politics,

Tax Policy Tidbits From the Major Presidential Candidates


Hillary Clinton:

Would like to see Bush tax cuts expire to help fund universal health care. Would raise “carried interest” tax rates on partners at private equity and hedge fund firms to 35 percent from the current 15 percent. Side note: though not an official endorsement, Warren Buffett, who, of course, has already made his billions, called her “the person to run the country” at a fundraising dinner.

Barack Obama:

Would like to fund health care reform by letting Bush tax cuts expire for Americans earning more than $250,000 a year; he'd keep them in place for the rest.

John Edwards:

Would also pay for universal health care by allowing Bush tax cuts to expire for top 2 percent of the nation's earners. Specifically, he'd raise the capital gains tax to 28 percent for those with incomes of $250,000 or more, and maintain 15 percent rate on capital gains for everyone else. He also said he'd eliminate the estate tax on estates worth less than $4 million, would “declare war” on off-shore tax shelters and put limits on executive compensation.


Rudolph Giuliani:

Would make Bush tax cuts permanent, would remove or significantly lower estate and corporate taxes, continue reducing the AMT and cut spending as well. He'd start by asking the department heads to recommend 5 to 20 percent cuts. He'd also replace less than half of the 300,000 government employees to retire in the next five years.

Mitt Romney:

Will cut taxes across the board. He'd make Bush tax cuts permanent, end the estate tax, and completely get rid of capital gains and dividend taxes for lower income folks. Would lower marginal tax rates for all individuals and corporations.

Fred Thompson:

The actor/politician has not officially entered the race. But, steeped in federalism, Thompson clearly wishes to shrink government back to a size more attuned with the Constitution. As for specific tax policy, he hasn't released one yet.

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