An interesting question to ask, since taxes affect the returns from stocks, is “Do stocks sell at lower prices in states that have higher taxes?” This question was posed to me by a reader who was actually using it to make the case that taxes do not affect stock prices. While he thought the answer was , “No, of course not since there is only one price for a stock”, the answer is actually, “Yes.” Here is why:
It is true that the current price of a stock is the same everywhere in the country since the stock is traded on the same exchange. An investor in Texas, which has no income tax, who calls his broker to buy shares of IBM at the market does not pay a higher price than a person in California, which has a high income tax, placing the same order at the same instant.
Individuals (at least those who are sophisticated about their finances) do take taxes into account, however, when making investment decisions. This means that those in higher tax states are more likely to make investments in assets that are not subject to state income taxes than those who live in low or no income tax states. The potential return for taxable investments must therefore be greater before those in higher tax states will buy them, in order to offset the loss in earnings due to taxes, than they need to be in lower tax states. This means that the price, relative to earnings, must be lower such that there is a better potential return. If the price is too high to provide a reasonable return, the investor in the high tax state will not buy the stock.
Note that another effect of having high taxes in a state is that people who tend to invest will move to states that have lower taxes. Note the flight of people from California, New York, and other high tax states to states with lower taxes. Taxes definitely have an effect on investing decisions.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.