ETFs: Thinking Post Health-Care

Two posts got me thinking over the weekend about the post health-care world.

The first is part of the same article we excerpted yesterday about municipal bonds. I didn't include this last part in that post because I did not think it was germane to an article about municipal bonds. However this thought is pertinent to those of us who have money tied up in stocks.

From The Barrons article on municipals:

"But long munis may ultimately be the only beneficiary from health-care reform. The stock market could well suffer in the long run. "When combined with potentially higher interest rates, inflation, and regulatory costs, a higher tax burden seems likely to stand as yet another headwind for [price-earnings] multiple expansion," write Strategas Research Partners in a note to clients.

Tax hikes during rallies in long-term, secular bull markets have proved particularly pernicious, Strategas also observes. In 1997, Japan hiked its value-added tax and aborted the recovery in the Nikkei. In 1936-37 in the U.S., the Roosevelt Administration imposed payroll and corporate tax hikes. Both of those increases were enacted as the "bill" for previous fiscal expansion came due."

{Link: Barrons: Health-care Winners. }

The other article was something I read over at Seeking-Alpha regarding taxation on dividends. Here are several excerpts:

"I am writing this article to convey my worries about the new paradigm shift that I see clearly arriving at our doorstep....{T}his new paradigm shift is basically that {the author} believe{s} that many high income investors will eventually switch out of dividend paying stocks and move into high growth, zero to low dividend players that have little or no debt on their balance sheets. ...

....In some states like California total tax rates {could} hit 50-60%. So the story going forward is very simple, those who are in these tax brackets will want to reduce their reportable income dramatically and the last thing they want is to own stocks that will just force them to pay higher taxes. Thus, there will be a shift to high growth, zero to low dividend payout stocks with little or no debt on their balance sheets..... Stocks with high dividend payout ratios usually have little growth associated with them. Thus, if you take away the benefit of the high dividend, you have very little reason to be in them.....{W}ith Capital Gains taxes going from 15% to 28% soon I would expect that most investors who have been in these stocks will sell over the next 8 months and move on to the new paradigm I outlined of high growth and low dividend payout stocks. This will be done mainly to pay the lower 15% capital gains rate."

{Link: Dividend Investors Beware}

First off I will say that I'm not so sure that I think investors are going to by and large make that shift. Individuals have been diversifying away from individual stocks for something like 20 years. Mutual funds, pensions and other institutional investors dominate the stock market now and they only rarely seem to think about tax consequences to their ultimate stakeholders. Individuals attracted to those stocks usually need income anyway and the tax consequences of their actions is usually not their primary concern.

As far as capital gains goes given what we've seen over the past decade it seems likely to me that unless Congress changes the law, individuals doing prudent tax loss harvesting can in many cases mitigate the effects of capital gains for sometime to come.

But these columns got me thinking about ETFs. In general ETFS are more tax efficient than mutual funds because they pay out much less in capital gains. Individuals holding them for years pay no taxes until they sell. I think tax considerations will increasingly become another arrow in the ETF quiver. Look for these characteristics to be trumpeted by the industry as the changes government is forcing on us become more apparent.