Falling markets will crush government budgets

A trader works on the floor of the New York Stock Exchange, August 21, 2015.


Brendan McDermid/Reuters

Investors are painfully aware of the crash in the stock and bond markets even now in 2022. Do federal and state officials realize the damage soon deteriorating markets will inflict on public and fiscal budgets? It seems that the tax revenue from capital gains will fall off a cliff.

Treasury’s monthly April statement indicates that capital gains tax revenue reached record levels in 2021. Markets are telling us that capital gains will shrink significantly in 2022. If what the statement and markets are suggesting is correct, the wealth reversal for the federation could reach Tax revenue to 250 billion dollars. In New York, Connecticut and other states that rely heavily on individual income taxes for revenue, the reversal can be devastating.

The last time markets crashed hard was during the 2007-2009 financial crisis, when the tax rate on long-term capital gains was 15%, well below the 23.8% rate today. Federal capital gains tax revenue fell 75% in two years, from about $140 billion in 2007 to $35 billion in 2009.

Income tax data for 2021 is not yet available, nor is capital gains tax data. However, there is a rough proxy that can give us a picture of what things stand for. The Treasury statement shows individual income tax receipts for the federal fiscal year to date, divided between “withholding” income tax — which is taxes on income earned from salaries and wages — and “other” tax payments, including taxes on all forms of investment revenue. The latest statement shows $776 billion in “other” income tax revenue for the first seven months of the current federal fiscal year. This includes April, which is clearly the biggest month of the year for tax returns. That’s $325 billion more than the next seven-month federal fiscal year total of $451 billion in 2019.

Historically, seven-month “other” income averaged a remarkably stable 70% of full-year totals, notwithstanding the turmoil in 2020-21 when the market slumped and recovered but with gains that were mostly short-lived. Usually, investors do not sell short-term positions. They wait and keep their winnings for at least a year, in order to qualify for beneficial long-term tax treatment on capital gains on sale.

If $776 billion in “other” income turns out to be 70% of the full-year figure, we can look at a record $1.1 trillion in “other” income for the 2022 federal fiscal year. Even if receipts have been declining in the past five months as the entry The fall of the market in 2022 comes into effect, it will still be a record year.

“Other” income tax receipts include many types of investment income, some of which may hold up despite the stock and bond market disaster. Real estate, for example, has been very strong.

It is possible to isolate the component of capital gains from total “other” income by looking at the data of the Internal Revenue Service. Capital gains tax revenue averaged about 30% of “other” individual income tax payments in 2013-19, a period when the capital gains tax rate was about 25%. Accordingly, capital gains tax revenue for 2021 could reach $330 billion.

A crash from the 2021 peak could be as bad or worse than the drop in 2008-2009.

Two factors can exacerbate and exacerbate market turmoil and lower capital gains tax revenue. First, interest rates on bonds were much higher in 2008 than they are now. That allowed a decades-old bull market to resume in bonds that lasted until the pandemic. Significant capital gains were available in bonds throughout this period. After the very low interest rates that prevailed during the pandemic, there is no longer a place for interest rates to rise. Falling bond prices will leave little prospect for capital gains on sales.

Second, in 2009, inflation was not a concern; In 2022, it reached its highest level in 40 years. The Federal Reserve is expected to raise interest rates significantly in 2022 — and keep them high until current inflation is tamed. This is not a promising economic and financial outlook for capital gains.

We’ll know better where we stand by mid-July, when the monthly Treasury statement shows income tax receipts through June. It will include “other” income tax receipts including the estimated quarterly income tax returns for June with updated capital gains estimates for 2022. A weak quarterly figure for “others” will doom capital gains tax returns.

Federal and state officials warning: If you wait until July or later for confirmation that a major source of tax revenue has dried up, you may have waited too long to start making the necessary budget adjustments.

Mr. Janke is the president of Connecticut-based Townsend Group International LLC.

The newspaper’s editorial report: Paul Gigot interviews former Trump economic adviser Kevin Hassett. Images: Getty Images / Bloomberg News / Reuters Composite: Mark Kelly

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Appeared on May 17, 2022, print edition as “Swooning Markets Will Crush Government Budgets”.

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