It is a politically charged topic – taxes.
Amusingly, the price of gold also captures the political world’s eye.
With certain elected officials arguing that now is the time to start taking more from the so-called rich for their pet social programs, it’s probably useful to look at how higher taxes on the rich might affect the price of gold and other precious metals.
As a couple of examples of the renewed interest in taxing the rich, consider recent actions in Switzerland and the United States.
In Switzerland, elected officials started imposing a 1% levy on individuals with earnings over €250,000 to cover benefits for the unemployed.
In the United States, elected officials increased capital gains and personal income tax rates from a low of 15% to as high as 39% for individuals earning over $400,000 per year. The tax increases were not earmarked for specific projects, but rather just a political desire on behalf of the Obama Administration to increase taxes rather than reduce government spending.
These two examples, of course, only capture a sliver of the renewed interest in taking money from those who have it.
How has the price of gold reacted to periods of increased government taxes?
The following has a short geographic and time-series look.
The first graph is a geographic plot of the World Bank’s total tax rate as a percentage of commercial profit indicator. The indicator starts in 2005 and ends in 2013.
Interestingly, northern African countries, most of the EU, the U.S., and around half of the South American countries impose high tax rates.
In contrast, many Arab countries, southern African countries, Canada, some EU countries, and many island countries impose low tax rates.
The following chart connects the price of gold with the international average tax rate.
Perhaps surprisingly, the price of gold is generally connected with government taxes.
The correlation comes out to -0.98, meaning the two are almost perfectly negatively correlated.
If one performed a simple linear regression between the two – as just an initial look – the effect of taxes on the price of gold comes out to -118 with a statistically significant p-value of less than 0.01.
The -118 means that if the worldwide average tax rate went from 43% to say 50%, as it was seven years ago, the price of gold would drop by about 49%.
This analysis is, of course, just for fun given the complexity of the gold market, but it does address some interesting issues.
Why would there be a correlation?
Here are a couple of explanations.
First, increases taxes on the rich reduces the amount of investable cash, which, in turn, reduces the demand for gold and other precious metals.
Second, the relationship may be due to political timing, meaning that governments increase taxes after recessions and other periods of economic stress, which, coincidentally, is when individuals hedging inflation risks may be shifting into other asset classes.
Third, a negative relationship might have to do with the timing of central bank balance sheet decisions, or more precisely, expected central bank policy decisions that affect their balance sheets.
Overall, taxing the rich may make for good politics. The practice, though, likely won’t help the demand for gold and other precious metal. Instead, the political pandering may put downward pressure on the demand for the world’s most popular stores of value.
