Some industries will benefit from health care reform while others will be left feeling sick.
On March 21 the House passed the Patient Protection and Affordable Care Act, along with the Health Care and Education Tax Credits Reconciliation Act. The combination of the two bills permitted the Senate to pass its changes to the health care legislation with only 51 votes, rather than a 60-vote super-majority. This massive legislation will fundamentally change the American health care system and who pays for it. While providing health care to 32 million uninsured Americans, the cost of that coverage will be very substantial.
The affluent will foot the bill. To finance the reform, the bill includes a 0.9% incremental payroll tax on earned income in excess of $200,000 for individuals and $250,000 for families. In addition, the act imposes a tax of 3.8% on unearned investment income for individuals with adjusted gross income above $200,000 and $250,000 for families. These new taxes are effective beginning in 2013. If you believe, as we do, that Congress will permit the Bush tax cuts to expire in 2010, you should expect the highest ordinary income bracket to go from 35% to 39.6% in 2011.
Dividend tax rates will also go up. Qualified dividends, which today are taxed at a maximum rate of 15%, will be taxable at ordinary income rates (which could mean that dividends presently taxed at 15% will be taxed at 39.6% plus 3.8% for Medicare, for a total of 43.4%, in 2013). Capital gains tax rates will go from 15% today to 20% in 2011 to 23.8% in 2013.
Note that expiration of the Bush tax cuts could be legislatively changed but somehow we doubt it. Washington isn't exactly flush with cash these days. In short, while the exact details could change, affluent investors can safely bet that their tax burden is about to increase and, in some cases, skyrocket.
The tax changes are kind to investors in tax-exempt municipal bonds, which appear to have escaped the 3.8% Medicare tax. Dividend-paying stocks appear to be most egregiously affected between the Bush tax cut expiration and the Medicare tax. Small-cap growth stocks, such as those followed by The Oberweis Report, don't typically pay dividends but would still be subject to the increase in capital gains taxes.
All in all, with the exception of the period around World War II, periods of rising tax rates have tended to correlate with periods of below-average GDP growth. Not shockingly, periods of lower GDP growth have also tended to correlate with less favorable returns in the stock market. That's not an encouraging signpost.
While not often mentioned, we believe perhaps the biggest victims will be American corporations that have large workforces of low-wage labor. For example, think about restaurant chains. It appears to us that they will be forced to buy health care for their employees. That cost will not be immaterial relative to their overall employment cost. We believe that the health care bill could cause stock valuations of retailers to decline in the months to come, all else being equal.
Drug makers, both branded and generic, stand out as winners. The pharmaceutical industry will get 32 million newly insured pill buyers. While partially offset by $80 billion in savings and rebates over a 10-year period courtesy of big pharma, drug makers will emerge as net beneficiaries. While some have hinted that the act will hurt generic companies, we believe they will actually benefit, particularly as the government is forced to clamp down on costs over time. The bill also includes a generic path for biologics, although the 12-year brand name period of exclusivity was longer than the five to six years hoped for by generic manufacturers.
Hospitals will benefit from a larger pool of insured patients, though the benefit will be partially offset by lower government reimbursement rates for Medicare and Medicaid. Companies like Medicaid fraud finder HMS Holdings ( HMSY - news -people ) and Medicaid health plan administrator Centene (CNC - news - people ) will benefit from an increase in the ranks of Medicare and Medicaid.
Losers on the bill include health insurers, private Medicare plans and indoor tanning salons (tanning salons will be subject to a 10% tax).
Political changes create dislocations in industries that smaller companies are well positioned to exploit. By carefully watching changes in tax rates and changes in the health care landscape, investors can best position to profit from the reform.
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