WEALTH MANAGER-Arnott sees tax hikes hitting US economy

* Research Affiliates warns tax specter will slow spending

* RA's Arnott warns less spending to further hurt economy

By Joseph A. Giannone

NEW YORK, July 19 (Reuters) - The specter of higher income taxes in 2011 will lead to reduced spending by the wealthy, which will drag on the already-weak U.S. economy, Research Affiliates Chairman and founder Robert Arnott told Reuters.

"The affluent are starting to save their resources in anticipation of higher taxes next year," said Arnott, whose investment strategies are used by money managers with more than $50 billion in assets. "That's the last thing a frail economic recovery needs."

In addition to pioneering work developing a fundamental indexing strategy, Arnott in early 2008 predicted that the housing market and consumer spending would crumble.

Arnott contends even the wealthiest of families will rein in consumption in anticipation that the Obama Administration, which has pursued massive stimulus spending to revive a moribund economy, will raise capital gains, dividend and income taxes.

The slowdown could become even more pronounced. Most analysts, he added, have not yet focused on this issue. "This will be a big story in the fourth quarter," he said.

Spending by the wealthy earlier this year briefly fueled a stock market revival. Sales at luxury chains outpaced those at department stores and discounters between December and May.

Moody's economist Mark Zandi last week, though, told the New York Times that high-end consumers have become "more jittery and more cautious," in recent weeks, a change in heart apparent in retail sales reports and analyst notes.

"The economic recovery is on shaky ground and the odds are better than 50-50 we will see a return to recession, induced by higher taxes, reduced spending and the forced withdrawal of stimulus by a government whose balance sheet can't take more burden," Arnott said.

By Arnott's reckoning, and using strict GAAP accounting standards, the U.S. deficit is closer to 18 percent of U.S. gross domestic product. Public debt, including unfunded social security and Medicare obligations, is far larger than the underlying economy.

"People want us to believe the financial crisis is behind us, but the leverage is still there: it's been shifted to the public sector," Arnott said.

Household debt has fallen for the first time in a decade, a reflection that families are spending less borrowed money. The big worry now is how Uncle Sam, which has amassed a record national debt, can ween the economy off stimulus spending.

Arnott has had a successful career challenging market convention. He is perhaps best known for challenging the popular practice of putting money into funds that track market cap-weighted indexes, such as the S&P 500, the engine behind hundreds of billions in mutual funds and exchange-traded funds.

That strategy, Arnott said, buys more shares in companies as they get more expensive. Instead Arnott's firm promotes fundamental indexing, which buys stocks based on financial performance. (Reporting by Joseph A. Giannone; Editing by Tim Dobbyn)