|Notice The Rainbow?|
I wasn’t sure I was going to even write about the upcoming potential “fiscal cliff” on this blog. Frankly, I’m not following any of the latest news out of Washington, as I don’t really care about politics or anything else that comes out our dysfunctional and argumentative headquarters USA. I always focus on the long-term. Changes in taxes and government spending levels have been almost as common as changes in Presidency. I’m investing in long-term opportunities, and my favorite holding period is forever. 4-year or 8-year changes in government taxation and spending levels are just blips on my radar. They can be pretty large blips, don’t get me wrong…but they’re still blips.
What I’m going to do is to give my quick take on things, and provide you some excellent links on this matter.
First, what is the fiscal cliff? It’s basically a term used to refer to the potential automatic spending cuts and tax increases that could occur if leaders in Washington do not come to terms on an economic plan going forward. This “cliff” would start at the beginning of 2013, and could be quite sharp based on the sheer amount of spending reductions and revenue changes, as well as the abruptness of it. It’s designed to quickly reduce the United States budget deficit. It is the jarring and rather messy nature of it that has some economists worried. There is no doubt that spending cuts are necessary as well as an increase in the revenue that the U.S. government takes in (due to our ever-expanding deficit), but the speed and nature of the cliff brings concerns of a potential recession with it.
For a rather robust explanation of the fiscal cliff, please visit the Wikipedia article: Fiscal Cliff.
I think the important thing that us dividend growth investors have been focusing on is the potential dramatic rise in dividend income taxation. The tax rate on dividend income, with the cliff, would automatically raise from 5-15% (depending on your ordinary income tax rate) on qualified dividends to a taxation level at your full ordinary income rate, with the cap coming in at 39.6%. I don’t particularly concern myself with this. First, I’m not at an income level to where this will have a large impact on my overall bottom line. Second, dividends have been historically taxed at higher levels. People tend to focus too often on the recent past and try to project this out into the far future. We’ve been very fortunate with very low dividend tax rates over the last decade. If dividends are allowed to be taxed at marginal income, that will be more along the lines of what dividend investors were faced with for decades before George W. Bush passed what’s now known as the Bush Tax Cuts, including the dividend/capital gains tax cuts.
Another thing to keep in mind is that companies that have long histories of paying and raising dividends will not be likely to all of the sudden change policy if dividends are all of the sudden taxed at levels that are truer to historical averages. Coca-Cola (KO) has been increasing dividends for the past 50 years. This is a company culture of rewarding shareholders that doesn’t just turn off overnight. Coca-Cola has been paying out dividends when they were being taxed at 50% and higher rates. I don’t anticipate them cutting off a spigot of dividends that have been flowing for over 100 years because dividend taxation doubles from a very low relative rate.
Also, as a dividend growth investor I seek to maximize my potential passive income. I also look to have a satisfactory total return, including capital gains (realized or unrealized). I do not, however, seek to avoid taxes. Seeking an investment strategy to avoid taxes would probably involve stuffing cash under your mattress. This is not intelligent investing. I, of course, would love to minimize my tax bill. But the choice between maximum investment gains and minimum taxes is obvious, especially when the latter choice usually comes with earning less money overall.
Would you ever say to yourself: “I wish I wouldn’t have gotten a $10,000 raise at work. Now I have to pay more taxes!” Probably not.
Overall, I feel that spending cuts and tax increases are necessary. The continued rapid expansion of our national debt cannot continue forever. The deficit must be addressed. Whether this happens through negotiations (unlikely), or a self-imposed “fiscal cliff” (more likely) is really of minimal impact to long-term investors. It will be painful at first, but the contraction of our deficit is good for the long-term economy. The key is to focus on investing in high quality companies that have a rich history of rewarding shareholders and do relatively well in any economic cycle. Companies like Philip Morris International (PM), PepsiCo Inc. (PEP) and Johnson & Johnson (JNJ) come to mind. People are still going to smoke, eat/drink and take medicine if taxes are higher. One only needs to look at how some of these companies performed in the recent Great Recession to have a good idea of how they’d perform in a tough economy post-cliff.
Now, as promised I’m going to share some fantastic articles from fellow bloggers on the fiscal cliff and how they may impact your investments.
How about you? What’s your thoughts on the fiscal cliff?
Full Disclosure: Long KO, PM, PEP, JNJ
Thanks for reading.
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