As promised, President Biden is proposing tax hikes pretty much across the board—on corporations, wealthy individuals, and capital gains.
Will Biden’s Tax Hikes Sink the Stock Market? Not Likely
As promised, President Biden is proposing tax hikes pretty much across the board—on corporations, wealthy individuals, and capital gains. That would be the first time since 1993 that taxes would be raised on all three of the primary tax baskets. To hear the financial media tell it, if Biden gets his way on all three tax hikes, it could unleash a “taxageddon” on the country, sending the financial markets into a death spiral. However, while big tax hikes can be a drag on the economy, history has shown that the stock market typically takes them in stride. There are three reasons why this time around, it shouldn’t be any different.
Biden Tax Hikes are Already Priced into the Market
The stock market has been aware of possible tax hikes under Biden since he started campaigning for the presidency. As a real-time pricing mechanism, the stock market is constantly digesting all available information as it looks six to twelve months or more into the future. It has been weighing and measuring the impact of future tax hikes and baking them into future valuations, which it then discounts to the present as represented by current stock prices. At this point, there is nothing new about tax hikes that could upset the markets.
Proposed Tax Hikes Likely to be Diluted
The stock market may also be factoring in a probable dilution of the tax changes. Unless Congress tries to ram an infrastructure bill through the reconciliation process on strictly partisan lines, the proposed tax changes are likely to be massaged through bipartisan negotiations. For instance, Biden has proposed a top corporate tax rate of 28%, up from the current 21% rate. That’s a significant increase and one that even a few moderate democrats may find objectional. Republicans are proposing to cut the difference with a 25% rate. We may see the same sort of horse-trading on the other proposed hikes.
Heavy Government Spending Acts as an Offset
Tax hikes rarely happen in a vacuum. There are usually other economic activities that accompany them, such as stimulus spending. These tax hikes are being proposed on the back of the most significant government spending bill in history. Historically, the stock market has viewed government stimulus positively, especially with the Federal Reserve acting as a backstop against inflationary pressures.
Some Historical Perspective
Although past performance is no indication of how the stock market might perform in the future, history does provide a keen perspective on the relationship between tax hikes and stock market performance.
Since 1925, the corporate tax rate has been raised 13 times, and individual tax rates have been increased 14 times. For corporate tax increases, the S&P 500 rose nine times in the 12 months following the tax hike, with an average annual return of 11.1%. For individual taxes, the S&P 500 climbed ten times in the 12 months following the increase, with an average annual return of 16.8%.
However, it’s the proposed capital gains tax increase that has everyone in a tizzy for its potential to sink the markets. The proposed increase would nearly double the rate to 39.6% from 20%. That’s a steep increase which many fear will spur a significant selloff to get ahead of the hike. Doomsayers also claim it will likely discourage capital investment which is central to sustained economic growth.
Not so fast. Since the capital gains system was instituted in 1954, there have been ten rate increases. In the year following nine of those hikes, stocks averaged a 10.7% return.
The Bottom Line
Based on the historical record, tax increases have primarily turned out to be “nonevents” as far as the stock market is concerned. That’s not to say that these proposed hikes won’t have some impact on economic and investment behavior—that’s to be expected. However, the stock market also assesses the offsetting factors of which there could be many, such as an increase in government spending or, in the case of capital gains taxes, extended buy-and-hold periods for investors wanting to avoid a higher tax.
The stock market has already weighed and measured Biden’s proposed tax hikes, which means anything that actually gets passed and signed into law is unlikely to cause a market selloff. That doesn’t mean we won’t see a significant market decline in the coming weeks or months—it just won’t be because of the proposed tax hikes.