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Hold Onto Your Wallet, Obama Gets Serious on the Fiscal Cliff

So much for a post-election rally. And so much for a sense of proportion. 

In the seven trading days following the election, the Dow Jones Industrial Average has dropped around 750 points, or about 5.6%.  For this, we can thank the permanent anchoring of Obamacare, and the devilishly divisive fiscal cliff

Obamacare is a welfare monstrosity, and it will certainly hurt business. But Obamacare is a done deal, so there is no more uncertainty (at least with regard to its implementation). Businesses will eventually learn to cope. 

The fiscal cliff, on the other hand, continues to roil financial markets. And understandably so when you consider the latest “compromise” put forth by President Obama

The president wants $1.6 trillion in additional tax revenue over the next decade, twice the amount he had discussed with congressional leaders in the summer of 2011.

I understand the ploy. Jack your demands up to ridiculous levels, then negotiate down from that ridiculous level.  And if you compromise, you'll project the appearance of rationality and bi-partisanship. 

At this point, the Republicans are unwilling to take the bait. But that could change as we approach January 1 and the pressure mounts to avert the wealth-sapping, economy-stopping tax-rate hikes that will take effect in 2013. 

And make no mistake, the tax-rate increases imbedded in the fiscal cliff are both wealth sapping and economy stopping.

Should we cascade over the fiscal cliff, income tax rates will rise in all income brackets.  (Ironically, the largest percentage increases will occur in the lower income brackets: The 10% income-tax bracket will rise 50% to 15%; the 15% income-tax bracket will increase 86% to 28%.) 

Higher income tax rates lower the rate of investment.  When you pay more in taxes, you've got less money to invest.  That's obvious. 

Less obvious is how higher income tax rates limit the quantity of investment opportunities.     

Investments are frequently valued on the discounted value of after-tax cash flows. Higher tax rates means lower after-tax cash flows, which in turn means fewer investments with a positive net present value. That is, fewer positive return investments.   

Fewer investments with a positive net present value isn't good for the economy. Contrary to popular belief, investment drives economic growth more than consumption. 

That said, the impending hike in capital gains taxes and dividend taxes is the more immediate concern to income investors. 

As part of his plan to get to $1.6 trillion, the president wants the long-term capital gains tax increased to 20% from 15% for the top two tax brackets (presently 28% and 33%).  He also wants dividends taxed at the ordinary income rate for anyone with adjusted gross income above $200,000 ($250,000 for a couple).

Top earners could see their dividend tax rate rise as high 43.6% in seven weeks, which is nearly triple the 15% rate today. 

The impact to income is immediate and onerous. An investor in the top income-tax bracket who realized $20,000 in dividends would pay $3,000 in tax in 2012.  Next year, if no compromise is reached, he'd pay $8,720.  That's unconscionable.  (Also, if there is no compromise, everyone pays his top marginal income-tax rate on his dividend income.) 

Many investors are desperate to preserve their income and wealth. I've seen an increase in investors moving money into tax-deferred accounts. Problem is, that's only useful if you don't need your dividend income today. 

Municipal bonds are another popular tax haven.  Investors don't owe federal income tax on qualified municipal bonds, but these bonds also don't yield much: A quality 10-year muni-bond yields only 1.6%. 

At High Yield Wealth, we've incorporated strategies for investors who need income and tax efficiency today.  These strategies protect current income because they incorporate high-yield investments whose income stream won't be impacted by the impending tax-rate increases. 

The Washington politicians have no qualms playing chicken – a game where two people race toward a cliff and the winner is the last to slam his brakes – with your wealth and welfare.

But that doesn't mean you have to participate.  And you won't participate, if you know the right income-protection strategies, like the ones offered at High Yield Wealth