One of the big discussions lately has been about how will higher taxes potentially impact the stock market. We’ve known since President Biden won the presidency and the Democrats secured control of the House and Senate that higher taxes were coming, likely in the form of higher corporate taxes and higher capital gains taxes on the wealthy—though probably not until 2022. It is worth noting though that stocks haven’t been fazed at all by all the higher taxes talk, as we just saw the best first 100 days for stocks under a new president since FDR.
With proposals for the $1.8 trillion American Families Plan (AFP) and $2 trillion plus infrastructure bill (known as the American Jobs Plan or AJP), higher taxes are needed to help finance the new spending. Let’s be clear though, with a 50/50 Senate (Vice President Kamala Harris breaks ties) and historically slim Democratic majority in the House, we think these final numbers will likely come in less than $3 trillion combined, as these initial numbers from the Democrats are starting points for negotiations.
Higher capital gains taxes on the wealthy are one way to pay for things, with the AFP proposing to increase the top tax rate on ordinary income to 39.6% from 37%, and capital gains and dividends taxed on those who earn more than $1 million to a maximum of 43.4% from the current 23.8%. Fun stat, only 0.32% of the population makes more than $1 million a year, so the truth is this won’t impact the other 99.68% of the population.
We’ve expected higher taxes were on the horizon so this shouldn’t be a surprise. According to Ryan Detrick of LPL, “Looking back at the times taxes increased amid a strong economy, stocks did just fine. Given the strong economic outlook this year, you’d have to think history could repeat once again.”
In 1986 and 2013, capital gains taxes increased, but the economy was on firm footing back then, compared with the 1970s hikes, which saw an economy marred by higher inflation and sluggish growth. Not surprisingly, the two more recent hikes saw solid stock market performance, while the 1970s hikes didn’t. Is it as simple as how the economy is doing? It very well could be.
Corporate taxes are currently 21% and President Biden has discussed increasing the level to 28%. Although we think in the end the level will be more like 25%, the bottom line is higher corporate taxes are likely coming, which could knock a few percentage points off of future S&P 500 Index earnings growth.
It’s always possible that higher taxes slowly take a bite out stock market returns over a longer time period than just a year, but if the concern is what all the talk about higher taxes may mean for markets over the next year, there’s not much historical evidence pointing to the potential for a bad outcome. The picture is murkier, though, with corporate taxes, which isn’t surprising, since stock prices are ultimately tied to earnings growth. Typically, markets seem to be more attuned to larger economic forces such as this tax increase.
As always, we encourage you to consult with your tax advisor before implementing any tax strategies.
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Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures success or protects against loss.