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Cadinha Blog


A Flat Tax?

We just heard President Bush give a President Reagan speech. He illustrated a vision and understanding of the dynamics of the marketplace. In short, the President’s position is better than we expected or even hoped for.

Obviously, the devil is always in the details and there is apt to be much dialogue and compromise between now and the ultimate legislation. Nevertheless, George Bush eliminated all the guesswork surrounding the Administration’s position. The Plan’s adversaries have yet to understand the President’s proposal for what it truly is, as they are challenging particular features of the proposal, when in effect, the pieces are “interlocked” into a 35% flat tax plan. All income at the highest level will be applied once against the same 35% tax rate, whether personal or corporate. This proposal represents a big step toward tax fairness, eliminating any incentive to use devious schemes to move corporate or personal money to a more favorable rate.

The effects of such a dramatic tax change will likely be felt soon after passage. Until then, investors should have time to calculate after-tax returns for the various asset classes and make a determination of what to buy and what to sell. There is a cash horde of approximately $7 trillion in this country looking for a higher after-tax rate of return. Rather than receive 1% interest before tax, perhaps a 2 to 3% taxexempt return in the form of a corporate dividend suddenly becomes attractive. Add an opportunity for growth to that equation, and the stock market becomes even more attractive. Areas of the market place featuring investments created to take advantage of the old tax code are likely to experience selling pressure. Fixed-income markets will likely see increased volatility as stock dividends suddenly compete with municipal bonds in the tax-exempt arena. REITs will no longer be unique in enjoying a “single tax” advantage. After all is said and done, we expect that well-established, well-managed companies with high cash flow will be the optimal choice. In the debt market, Treasuries will be the choice as corporate debt is called and municipal bonds are forced to compete with dividend-paying stocks and contend with growing fiscal deficits. It will be interesting, to say the least.

We expect the political battle over this issue to be a fierce one. Even static scoring, the myopic forecasting methods used for decades by the Congressional Budget Office will likely change in favor of dynamic scoring. This change will likely lower cost estimates of this tax package by approximately $200 billion. In the end, we expect the President to prevail as fairness is on his side. If however, the class warfare, large government arguments prevail, we will likely take a more dim view of the outlook for the markets and the economy. For the present, anyway, we are very optimistic.

About the Author

Harlan J. Cadinha
Founder, Chairman and Chief Strategist




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