Schweser sates this: “Because corporate income tax and capital gain tax are not indexed to inflation, inflation can reduce the stock investor’s return, unless this effect was priced into the stock when the investors bought it”
Can anyone help me understand this statement? I particularly don’t understand how investor’s return will be reduced as a result of the taxes.
Thanks.
Thirty years ago you would get an 8% return on your stock, and, because your taxable income was $60,000, you’d pay 20% income tax, leaving you with 6.4% net. Today you get an 8% return on your stock, and, because your taxable income is $120,000 (the inflation-adjusted equivalent of $60,000, 30 years ago), you pay 35% income tax, leaving you with 5.2% net.
If the income levels for tax brackets were indexed to inflation, you’d be paying the same 20% tax on the equivalent (inflation-adjusted) income; because they’re not indexed to inflation, your tax rate goes up even though your purchasing power remains unchanged.
Thanks for the explanation.
I get the point, but it’s a bit of a strech. Firstly the inflation impact on your income and thus on your tax bracket is exogenous to the investment. Secondly most governments will adjust the tax brackets over time to allow for inflation.
And also there will be many people who are not seeing wage inflation at present so no inflation effect again linked to the exogenous impact I mentioned. And for those who say that your wages would need eventually to be inflation adjusted to avoid impacting purchasing power the same arguement should be made for taxes.
I’d just like to point out I have no issue with Magician’s explanation of the Institute’s point, more with the Institute’s point itself.