Though the Carter administration's tax revision plan has yet to be introduced - and it now looks like October at the earliest - a number of proposals already have surfaced.
And Wall Street already is beginning to chew over the implications some of these changes could have for investors and investments.
Right now, based on advance signals from Treasury Secretary W. Michael Blumenthal, the administration is expected to propose three significant shifts in the tax code that would affect individual investors.
The first is total elimination of the capital gains preference, which has allowed investors to shelter half of their realized gains on investments from the tax man provided they held on to them for a minimum period, currently a year.
In place of this inducement; the legislation probably will include a 50 per cent ceiling on the tax rate applied to all personal income. Right now, the ceiling is 50 per cent on income received as wages, and 70 per cent on other income.
And the anticipated capstone proposal would be elimination of the double tax bite the government now puts on corporate dividends, first as company earnings and then as investor income.
If this combination of changes gets introduced and enacted - and that's a big if - the emerging thinking in the financial community is that it could shift significantly the total after-tax return to investors on different stocks in different ways, and therefore alter the relative appeal of various equities.
Companies that pay high dividends, like utilities, would become even more desirable they have been in demand anyway for the last few years as investors sought the safety of high yields), because most, if not all, of the tax that now must be paid on dividend income would be eliminated.
Conversely, stocks with good growth potential but little or no dividend payout would suffer because appreciation in price would be translated into smaller aftertax returns when the capital gains preference goes.
Such an analysis is contained in a report put out recently by William W. Helman, chairman of the investment policy committee at Smith Barney, Harris Upham & Co. The report actually calculates the effect of possible tax changes on both large and small investors for different stocks, depending on their yield and growth potential. Here are a few examples:
Under the current tax laws, a $1 investment in a stock yielding 12 per cent and having zero growth potential would be worth $1.42 to a large investor after 10 years. A large investor is defined as one who is in the 70 per cent bracket and who pays a capital gains tax of 45 per cent. (It also assumes reinvestment of dividends and payment of the capital gains tax at the end of the 10 years).
Providing all three tax changes take place, and other things remain equal, that same $1 investment would be worth $3.11 in 10 years, an improvement of 119 per cent.
On the other hand, each $1 socked into a stock that pays no dividend but whose per-share earnings are growing at a 12 per cent annual rate would be worth $2.16 under the current tax laws after 10 years.
After the possible tax changes, however, that $1 on the high-growth stock would be worth only $2.05, a reduction of 5 per cent, and considerably less than the high-yieldings, no-growth stock.
Between these extreme, $1 invested in a stock with 7 per cent yield and a 5 per cent income growth record would appreciate to $1.70 under the present system. After the changes, it would be worth $2.79, or an increase of 64 per cent.
Helman provides many more examples, but these present at least a broad-brush picture of some of the effects of the tax changes now being considered. A lot depends on what proposal fnally is adopted for eliminating the double taxation of corporate dividends.
The Smith Barney report assumes it will take the form of a tax credit available to shareholders for U.S. income taxes paid by the corporation on the dividend it distributes.
For example, if a corporation with a pretax income of $1,000 pays U.S. income taxes of $400, or a $40 per cent rate, and a dividend of $300, the shareholder who gets the $300 would declare as income the corporation's pretax equivalent of the dividend he receives, or $500. He first would compute his tax on that amount. If he is in the 50 per cent bracket, that would be $250. Then he would deduct the tax paid by the corporation on the dividend, or $200. His tax then winds up being $50. That contrasts with his tax under the present system of $150, or 50 per cent of the $300 dividend he receives.
A taxpayer in a lower bracket, say 20 per cent, could benefit even more. In his case, he would compute 20 per cent of the $500 precorporate tax dividend, making the tax owed only $100, against which he deducts as a credit the $200 already paid by the corporation. This means he would end up paying no taxes at all on the $300 dividend. And he also could be allowed to use his $100 credit against other income. Under the present law, his tax on the dividend would be $60, or 20 per cent of $300, and his after-tax net would be $240.
"Of importance in thinking about the dividend credit is that; under the full-credit idea, the availability of the credit will depend upon the amount of U.S. income taxes actually paid by the corporation," Helman notes.
So the companies that would prove most attractive to investors in the event the changes take place would be those that not only pay out large dividends for a high yield, but those whose income is mainly domestic rather than foreign, and who must pay U.S. income taxes at close to the maximum rate.
Another potential impact of these tax shifts could be to pressure companies to pay out more of their earnings as dividends and keep less for reinvestment purposes, an undesirable result. So this would have to be offset by some kind of improved investment tax credit, which is also expected to be in the legislation. There are many other possible investment implications as well.
In fairness, the administration still has not introduced its legislation, nothing is yet in concrete and final legislative passage could be many years away for such a complicated revision.
The point to be made about this analysis, however, is that even the smallest change in the tax laws often winds up having unanticipated consequences of shifting where the resources and investment flows go into our nearly $2 trillion economy.
The kind of comprehensive tax overhaul that the Carter administration is looking at could set off massive - and unwanted - changes in how individual investments are assessed.
The purpose of the proposed tax changes are supposedly twofold: to improve the fairness of the system by removing special preferences for different kinds of income, and to stimulate investment in order to provide companies with the equity capital they need to expand.
But creating an investment bias toward high-dividend yields could end up making it even harder for new companies to raise money in the stock market because their promise historically has been future growth and the prospect of capital appreciation, not current payouts.