What’s Worse: High Taxes or a Down Market?

BOSTON (TheStreet) — Investors are jittery about the stock market's decline to a 10-month low earlier this month, and many are piling into bonds. But they may have more to lose in the form of higher taxes.

Although a dip in stocks is immediately felt in investment and retirement funds, new and increased taxes could inflict a far-reaching and long-lasting erosion of assets. Is, for example, a temporary 25% drop in stock prices any better or worse than having profits slashed in equal proportion by the tax man?

"Market cycles come and go but tax rates can stay for a very long time," says Ron Florance, director of asset allocation and investment strategy at Wells Fargo's (Stock Quote: WFC) private-banking unit. "One of the things investors need to look at is that what you earn in your portfolio isn't really that important. What you earn after you pay your taxes is what determines your lifestyle."

An advisory to Wells Fargo clients referred to the past few years as the "Golden Age" of taxation for investors. Since 2003, when the federal income-tax rate on dividends and long-term capital gains were reduced to a maximum of 15%, concern about tax rates disappeared. With Bush-era tax cuts set to expire at the end of this year, it is again time to focus on strategies that defer capital-gains taxes or shelter dividend income.

It is still unclear which taxes will increase and by how much. But heading into next year, there are some likely scenarios, especially if Congress takes no action to extend sunsetting rates.

The Obama administration's budget proposal — confirmed Wednesday by Obama's secretary of the Treasury, Tim Geithner, on CNBC's The Kudlow Report — calls for the rate on long-term capital gains to return to 20%, up from 15%, with short-term capital-gain rates remaining at the taxpayer's marginal ordinary income-tax rate. Qualified dividends no longer will be taxed like capital gains, but instead be treated as ordinary income. For those in the highest brackets, the rate returns to 39.6% from 15%.