On the campaign trail, President Biden proposed increasing the corporate tax rate from 21% to 28%. If successful, we estimate this would be an 8% drag on S&P 500 earnings. However, in our base case, we assume Congress approves a tax hike that is only half as large—so a 4% drag on profits. This is embedded in our expectations for 13% growth in S&P 500 EPS in 2022.
If the corporate tax rate remains unchanged, earnings could grow closer to 17%. Higher corporate taxes could be a modest drag on equity markets but US companies should still produce healthy profit growth. There may not be many relative winners and losers across sectors because President Biden's campaign proposals called for an increase in the domestic tax rate as well as provisions to raise taxes on foreign income. Also bear in mind that tax increases will be used to at least partially pay for infrastructure spending, which would tend to boost economic growth and offset some of the drag from higher taxes.
In addition, President Biden has proposed an increase in capital gains tax rates. Last October, we showed that historically, changes in the capital gains tax rate have had almost no impact on overall market returns. In fact, the last time the capital gains tax rate increased (in 2013), the S&P 500 rose about 30%. And capital gains tax rates have very little relationship with valuations.
Still, if capital gains taxes do rise, there will likely be implications for individual taxpayers. But we think the impact on the broader market will be de minimis.
Discussions on the next fiscal package are at a very early stage, and it will likely take many months before investors will have clarity on the details of the next big policy initiative out of Washington. But ultimately we believe the recovery from the pandemic will continue to be the main driver of further equity market gains.
See original blog post Higher taxes: Equity implications March 25, 2021.
As a reminder, our POTUS 46 stock list is designed to benefit from President Joe Biden's likely policy priorities (see "POTUS 46: Investing under a Biden administration," 26 January 2021).
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