After almost a year of heated debate, the President has achieved his goal of a major reform to the health care system. The House voted on Sunday to approve the 2409-page Senate bill passed in December along with 153 pages worth of amendments, on the understanding that the Democratic majority in the Senate would accept these amendments without alteration. Today, President Obama signed the bill into law.
So what does all of this mean for investors?
First, we need to recognize that in discussing this issue, like any other issue in investing, it is critical to leave politics and emotion to one side. People have very strong opinions on all sides of the health care debate-they are entitled to those opinions. These comments are solely focused on the investment implications of the combined bills.
So passing over the generally recognized positive of expanding coverage to roughly 30 million of the 50 million U.S. residents who don't currently have insurance, what does it all mean for the economy and markets?
Taxes: The most obvious quantifiable impact of the bill is an increase in taxes for upper income Americans, particularly on investment income. Starting in 2013, the Medicare tax rate on households with income over $250,000 will be increased from 1.45% to 2.35%. In addition, a new 3.8% Medicare tax will be introduced for the same group on investment income.
Currently, the tax rate on dividends and long-term capital gains is 15%. In 2011, those rates are expected to rise to 20% for households earning over $250,000 and with the new Medicare tax, these rates will rise to 23.8% for the same group. Under current tax law, investors get to keep 85% of the income stream from taxable stock market investments. Under this new law this will be cut by 8.8% to 76.2%, reducing the value of the income stream by 10.4% (that is 8.8% of 85%). This is obviously a significant number. However, it is worth noting three things about this:
First, roughly half of U.S. stocks are owned by households with income under $250,000 and roughly half are held in non-taxable accounts. Thus, using a number of broad assumptions, the value of the average stock should be reduced by one quarter of 10.4% or 2.6%-not good obviously, but also not an overwhelming reason to avoid stocks after 12 month period in which they rose by over 70% and still appear undervalued.
Second, this bill does not put stocks at a further disadvantage relative to fixed income. The maximum federal tax rate on bonds and cash accounts is currently 35% and with tax changes coming in 2011 combined with these changes, that maximum rate will rise to 43.4% for households with income over $250,000 in 2013.
And, third, it's not like we haven't been here before. On average over the past 40 years the maximum federal tax on capital gains was 24.7% and the maximum tax rate on dividends was 44.6%.
For the medical care industry, this bill will expand demand without much effort to reign in costs. A combination of federal subsidies and mandates will increase the pool of insured, and while there are many constraints preventing insurance companies from limiting coverage, there are few which limit how much they can charge for it.