As prices rise, the existential risk in the market is related to inflation. As inflation goes up so will interest rates which has negative implications to future cash flows (this disproportionately negatively affects tech companies). Regarding rising interest rates and during a rising inflationary period, the surest way to survive is to keep growing faster than the rate of rising costs. Chamath Palihapitiya, Social Capital 2020 Annual Letter
While investors react nervously regarding factors like inflation, government gridlock in Washington, and geopolitical and macroeconomic issues around the world, the stock markets continue their broad selloff. While the $1.5 trillion bipartisan infrastructure bill has passed the Senate, the legislation has been stalled in the House of Representatives, and some pundits are questioning whether the legislation can be passed due to political wrangling among Democrats.
The U.S. tax code broadly incentivizes savings for two different reasons:
- To ensure that people accumulate enough wealth to be able to support themselves during retirement.
- The nation’s savings provides capital for businesses to borrow, invest, and expand, which is necessary to increase economic growth.
The tax code incentivizes savings in several different ways:
- The U.S. does not tax investment returns until the person actually realizes it—an investor who owns a stock that doubles in price doesn’t pay the IRS until he sells it.
- It taxes certain investment income—most notably capital gains—at a lower rate than ordinary income.
- Investors can make investments via a variety of tax-preferred savings accounts, such as individual retirement accounts (IRAs) or their 401(k) retirement accounts set up by their employer.
An investor can either deduct the money he puts into the account from his ordinary income and then pay taxes on the money only when he takes it out upon retirement (traditional IRA and 401(k), or he can pay taxes up front on the income and then the money in the account goes untaxed upon withdrawal (Roth IRA).
A retiree with $1.5 million in his or her 401(k) will discover that taxes will consume 25 to 35 percent of every withdrawal which dramatically reduce the financial freedom of the retirement nest egg.
Proposals in Congres to pare back this tax break—such as by assessing a tax on unrealized capital gains each year or treating capital gains income the same as ordinary income—have fortunately foundered. The former would be unworkable for many people (the year after a robust stock market would a trigger a big tax bill for anyone with a stock portfolio and force millions to dispose of a portion of their investments) and the latter would also effectively reduce savings by greatly reducing the long-term real returns.
References:
- https://www.forbes.com/sites/ikebrannon/2021/10/04/thiels-roth-account-is-not-a-policy-failure/
- https://www.socialcapital.com/annual-letters/2020