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In this world, nothing is certain except death and taxes—and apparently, tax hikes under President Joe Biden.
Biden wants to spend more than $2 trillion on an infrastructure package that includes more than just infrastructure, a theme Barron’s delved into last week. To get the job done, he’ll need to pay for it, which means higher taxes.
Under his proposal, the corporate rate would jump from 21% to 28%, while capital gains for those earning more than $1 million annually could go from 21% to 39.6%, and individuals making more than $400,000 would pay 39.6%, up from 37%. The final numbers might change, but don’t be surprised if the direction remains the same.
The market appears to be ignoring the possibility. The
has gained almost 4% since the day before the plan was announced on March 31, and has hit new highs. That’s largely because investors expect taxes to be offset by spending and a booming economy. Yet history suggests that would be a mistake. The S&P 500 has returned an average of 2.4% in the 13 years in which both corporate and individual taxes rose, according to BTIG data, compared to 8% during all years. The following year has been even worse, with the S&P 500 averaging a 0.9% loss.
Sources: UBS; Goldman Sachs; FactSet
“Common wisdom has it that equities are indifferent to tax hikes,” says Julian Emanuel, chief equity and derivatives strategist at BTIG. “They aren’t.”
The lack of investor response could prove to be just a matter of timing. The S&P 500 did not react to tax cuts under President Donald Trump until just a month before they were passed by Congress, notes David Kostin, Goldman Sachs’ chief U.S. equity strategist, likely because no one knew what the law would actually look like. The same is probably true for Biden’s tax hikes, if they pass.
“Within the equity market, the relative winners and losers of the next fiscal package will depend on the specific provisions,” Kostin writes.
Higher capital-gains and income-tax rates are a risk to equity valuations and consumer spending, respectively, but the biggest risk is from higher corporate taxes, which would have a direct impact on earnings. Particularly vulnerable are companies that pay low tax rates on overseas profits, who would be forced to pay a 21% GILTI—or global intangible low-taxed income—tax in the U.S. on those earnings. Many of these companies won’t get much benefit from domestic fiscal spending, making them doubly exposed.
All told, the S&P 500 could take a 7.4% hit to earnings from the planned tax increases, assuming the plan passes in its current form, says UBS strategist Keith Parker, though he expects the actual impact to be about half of that. Information technology, communication services, financials, consumer discretionary, and healthcare all have greater exposure than the overall index. Companies exposed to hikes include
(ticker: LRCX),
(AMGN),
(WU),
(ILMN), and
(AAPL).
“The potential for higher corporate taxes is likely to be a notable head wind for the most affected stocks,” Parker says.
Even if investors are ignoring the threat for now.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
