I Can't Help But Notice Tax Policies in Other Countries

I just visited Budapest for the first time...

Straddled across the Danube River, the artery of Eastern Europe, Budapest is the charming capital of Hungary.

The history of Budapest is one of constant change. Around 600 years ago, what would become the city of Buda was refounded after the Mongol invasion. Hundreds of years ago, it flourished as a site of Renaissance art in the Austro-Hungarian Empire. Eventually, it grew large enough to combine with the city of Pest to form Budapest.

While the city has always been a tourist destination, after World War II and the start of an authoritarian U.S.S.R.-dominated Cold War state, the city was relatively closed off to Western travelers.

Beginning in 1989, with the fall of the Berlin Wall, the doors to the city began to reopen, and Hungary has had something of a rebirth over the last three decades.

I enjoyed walking around Budapest and seeing the sights. It was cold but not too cold. I focused on what people normally focus on when they visit such historical cities for the first time: the architecture, food, local customs, and traditions.

Of course, you must change money, so you're forced to notice the local currency of any economy. In Hungary, it's called the forint ("HUF").

While inflation is relatively stable today in Hungary and has been for some time, it wasn't always the case. Years of hyperinflation grossly devalued the currency. So, changing just $100, you find yourself the owner of nearly 31,000 Hungarian forints.

However, just looking at the money and exchange rate isn't enough. To really understand the local culture and its economy and where it may be heading, you must dive into the tax policies.

Learning about Hungary's taxes tells you much about the country...

After the Soviet Union collapsed and the collectivized markets of Eastern Europe were looking to modernize, Hungary was looking to kickstart growth to match its Western counterparts.

One way the country did this was by changing its tax structure. In the West, it is traditional to have progressive taxes. As every U.S. taxpayer knows, the more you make, the higher your income tax bracket.

But Hungary has taken a different, with a more accommodating approach to spur business and wealth creation.

Since 2012, the year its new constitution was adopted, the country implemented a flat 9% tax rate for corporations and just 15% for individuals. And it doesn't go any higher...

Of course, this reduces the tax burden for companies and people and helps drive growth and investment.

The country has also eliminated taxation on dividends, which eliminates the "double taxation" problem that we have in the U.S. (Double taxation is when a government, like the U.S., takes a percentage of corporate earnings twice before it ends up in equity holders' pockets.)

Thanks to greater aggregate spending, businesses in Hungary have boomed, and tax revenue is up. Everywhere I walked and drove around Budapest, I saw construction, with new businesses... And I saw a lot of people with a sense of hustle.

It's no wonder. When people keep more of the money they earn, they tend to work harder. When businesses keep more of their money, they either use it to grow more or dividend it back to the shareholders for future spending or investment.

I should note that the value-added tax ("VAT"), like a sales tax, is 27% – the highest in the European Union. With that, people have a strong incentive to make more, invest more, and spend less.

Last week in the U.S., I conducted a program on income tax policy and its impact on markets and economies. If you're to be any good at understanding bull and bear markets, you must have a deep understanding of how changes in tax policy can change market behavior.

The fact is, when you increase taxes on things, people do less of it. People tend to spend more when you decrease taxes on things. For instance, if you increase taxes on gas heavily, people drive less and might buy more fuel-efficient cars.

If you increase taxes on cigarettes massively, otherwise known as a regressive tax, people buy fewer cigarettes. Very specifically, every price increase of 10% on cigarettes reduces consumption by about 4%.

It's no wonder that when the government taxes capital gains and dividends more heavily, people are less active in the stock market...

With all the talk about the impact of inflation on the stock market, which can be serious, it can pale in comparison with the impact of tax policy changes on stock valuations. That's an issue that a great many politicians miss.

If there were a large hike in capital gains taxes, such as certain recent proposals to double the capital gains rate to 48.5%, it would trigger the biggest bear market in the last century.

There is no way the government can raise total taxes on capital gains from the 20% levels to nearly 50% levels without destroying activity in the stock market, along with its valuation.

Thankfully, we feel that the odds of this kind of tax hike are low, as just enough lawmakers realize this to prevent it from happening – at least as of now. Of course, it is something to monitor, as we do in our market research.

I hope each of you has a great weekend and week ahead.

Love, joy, and peace,

Joel
February 11, 2022