Beach Reading: Bennicas & Associates June 2021 Letter

Okay, it might not exactly be beach reading, but take a moment to read our thoughts on inflation and taxes.

June 2021

It’s a wonderful early summer as we relearn what it’s like to venture out without masks, and with a confidence that the world is returning to normal. As Bill Gross quipped, it may be a “new normal”, and that still feels pretty good. We hope that you are feeling confident yourselves, and that you can get back to the things that you love and missed so much. Let’s all go out and have some fun!

You’ve probably read about the draconian retroactive capital gains tax plan that has been unveiled within the current FY 2022 budget proposal. The budget itself comes in at $6 trillion. For reference, the last pre-COVID budget in 2019 came in at $4.48 trillion. 2020 ballooned with emergency spending, and it does not appear that the government plans to slow that pace down. This stimulus is behind the rapid increase in real asset prices, including everything from lumber, to lithium, and your morning cup of coffee. We’ve each heard many anecdotes of cost increases. Michael got a call from the carpenter building his small shed explaining that his costs are up 30%, and that he’d like to ask for a 10% increase in the price he quoted. Clearly, that contractor is not located in the Bay Area. And anyone who has booked travel recently has likely also considered taking a home equity line to pay for the trip. As you know, we have prepared for this in your portfolios by diversifying, featuring commodities and precious metals, and avoiding the markets highest flyers, which have the furthest to fall (should a real correction ever occur again). The essence of our investment philosophy is to keep up during bull markets, and decline less during bear markets/corrections. Declining less is much more valuable than wringing every penny out of the upside. That makes market and inflation hedges worth the investment.

Revisiting the proposed capital gains tax, the White House’s plan is to raise the top tax rate on capital gains from 23.8% to 43.4%. For Californians this capital gain rate is effectively higher because of the 2017 changes to the deductibility of state income tax, property tax, and mortgage interest. And when you add California’s capital gains tax of 13.3%, you’re talking about an all-in capital gains rate of nearly 57%. This is shocking, and loaded with economic risk. California has seen competition for its businesses in recent years from other states. We can expect this to accelerate. Capital gains have long been treated deferentially compared to ordinary income. The logic is that if you have the temerity to put your capital at risk, say, building a business or investing in a commercial property, you should be accorded a lower rate on a gain due to the risk of loss of your capital, as well as to encourage the economic stimulation from long term investment. To us, this is a very concerning aspect of the proposed change. We are not in favor of treating risk capital like it’s invested in a sure thing from the get-go. In addition, similar to dividends, there is a double taxation issue with capital gains, as much of our original capital invested in taxable accounts has already been taxed (as income or inheritance). For contrast, consider that China assesses a 20% capital gains rate, whether short or long term, and 0% on the sale of a private residence. A silver lining of the retroactive plan is that it’s too late to do anything about realizing capital gains at the lower rate. That means that there won’t be any pressure on stocks from gain-realizing selling that we could have expected to take place otherwise. And that’s a pretty thin silver lining. The prospect of this capital gain structure will hang over business investment delaying capital allocations to employment, research, development, plant, and equipment. The US has a higher cost of doing business than many competing countries because of wages, regulatory, health & safety, and myriad other considerations. Despite those competitive headwinds, US companies manage to lead the world in critical areas such as drug development and technology. We are concerned that such a high tax structure could permanently impair that edge.

One way to blunt the effects of high capital gains taxes has traditionally been to hold on to assets until death, and pass them along to heirs with the cost basis of their value “stepped up” to current market. This too looks to be on the chopping block, as unrealized capital gains would be taxed upon death. In many cases this would ensure that those assets, whether a business, a collection of coins, or a lakeside cabin would have to be sold to pay the tax bill. We are very surprised that the market responded to this news, and the related confusion around “can they do that?”, with a collective shoulder shrug and a ho-hum. We can expect that to change to a far more anxious response if this proceeds as planned. Markets dislike insecurity; between the corporate tax hike, and treatment of capital gains, there’s some confusion and consternation brewing.

Alfred E. Neuman

If you feel like we do, we would suggest sharing your thoughts with your elected representatives. You can find your Congressional representatives here: https://www.house.gov/representatives/find-your-representative. You can find your Senators here: https://www.senate.gov/senators/senators-contact.htm.

Bennicas & Associates News

We are working on some of the office backyard creature comforts that we have been looking forward to for some time. It won’t be long before we can finally host our long-awaited open house and party in our new office and patio. We are hopeful that this will be sometime this late summer, or early fall. We will keep you posted!

With the addition of Michael to the team now 8 months ago, we are ready to begin accepting new clients. We’re looking forward to growing our business again in our new offices, and with Michael’s help to pitch in. Additionally, as we grow, we would expect to be able to elicit further favorable considerations from partner firms Schwab and Fidelity, such as fee waivers for transfers, and lower commissions, etc. So, if you have any family or friends that you think might find our services to be helpful, please consider passing our information along or connecting us personally. Thank you.

Finally, our offices will be closed on Friday, June 18th in observance of Freedom Day (also known as Emancipation Day), Saturday, June 19th.

I Am a Man, by Marcellous Lovelace, Memphis, TN

Thank you for your interest in Bennicas & Associates. Feel free to contact us anytime at MoreInfo@Bennicasandassociates.com.