Stocks may suffer if capital gains taxes rise

• As election nears, debate over taxes on stock profits heats up
• Stock market tends to fall after tax hikes on capital gains
• To trim deficit Obama wants to boost tax on stock profits from 15% to 20%

NEW YORK — Everybody knows that when income taxes go up, Americans' take-home pay goes down. But investors might not know that when the government raises taxes on stock profits, the market is likely to go down, too.

Ever since the so-called Bush tax cuts were passed in 2003, the government has levied a 15% tax rate on stock market profits, known as capital gains, as well as stock dividends.

But those investor-friendly tax rates on winning stock trades could soon be going up, depending on how the political winds blow in Washington. Reducing the after-tax return on stocks could cause a headwind for Wall Street, because it could make the market less attractive and put a dent in the rally that has pushed stocks to their highest levels in almost five years.

Since 1969, the capital gains tax has been raised three times. The two times rates were increased without being part of a comprehensive tax-reform plan from Congress, stocks were down sharply six months later, data from Strategas Research Partners show. In 1986, when lawmakers increased capital gains taxes but also slashed rates on income and business taxes, the market was 22% higher six months later.

"We believe investors should be asking about the impact of capital gains tax increases on market performance," says Daniel Clifton, a policy analyst at Strategas.

If Congress doesn't act to extend the Bush-era tax cuts, which expire at year's end, the tax rate on capital gains will return to 20%, where it was during Bill Clinton's presidency.

As part of his deficit-cutting plan, President Obama said if re-elected he would boost the tax on stock profits to 20% for those making more than $200,000 ($250,000 for married couples), and tack on an additional 3.8% investment tax to help pay for his health care plan. High-wage earners would also see their dividends taxed at the higher income rate under Obama's plan.

Mitt Romney, the Republican candidate for president, wants to keep the current 15% rate permanent for capital gains and dividends and eliminate the levy altogether for taxpayers earning less than $200,000.

Any additional taxes on stock-related income is a negative, warns Andrew Busch, a public policy strategist at BMO Capital Markets. "Higher taxes takes the luster off stocks for sure," says Busch, adding that it could also prompt investors to dump stocks now while tax rates are low.