Closed Door, Open Window

May 5, 2021

Last week saw the first time President Biden addressed the joint session of congress. And for most, including yours truly, it was the first time I’ve really heard the agenda from the current administration laid out. It’s probably more political fatigue that has kept me from not following as much as I normally do, but his speech presented a Democratic wish list. “A generational investment”, was quoted a few times throughout it, a phrase most fiscal conservatives shiver when hearing. 

Don’t believe everything you hear when it comes to this. Over the past couple of months, I’ve fielded a few calls about the effect of higher taxes and what it means both individually as well as economically. Will my taxes go up? Will this kill the stock market? Do I need to move to Canada? 

We are very much in the rhetoric phase of this presently. Speeches like last week’s address is an attempt to gather public support for an idea and/or concept. It’s a negotiating tactic, to bring the other party to the table. Nothing more, nothing less. If I had to predict where we ultimately land on this, I would guess that capital gains taxes will go up, for incomes of over $1 MM per year. I doubt the figure will be as high as current income tax rates for the top end of 37% but will likely be higher than the 20% currently. Preferential taxation on long term capital gains dates back in one form or the other to 1913. At that time capital gains were taxed at a maximum of 7%. The last four administrations have had some changes to the rates, although the preferential treatment of capital gains has been consistent throughout. 

As for corporate taxes, there are a few proposals out there. A rise in the corporate tax rate from 21% to 28%, a minimum tax for companies that book profits of $100 million or more, and doubles the Global Intangible Low Tax Income, (basically a higher tax for foreign subsidiaries of U.S. companies). 

So, let’s say that the Democrats get everything they want in this proposal. This would be an impact on corporate profits. To what extent? Our best guess is somewhere around 15% hit to earnings next year… Mainly affecting the tech and healthcare sectors, which obtain a good portion of their revenue and profit from overseas. 

Set aside the doom and gloom for a minute as I lay out what I think will happen. You could see corporate taxes go up, but probably to 25%. An AMT (Alternative Minimum Tax) could be imposed, but I feel there will be many loopholes to this, that it hits only those companies that want to pay it. Under this scenario we probably only take a 7-9% hit to earnings next year. Remember what I always say, “It all comes back to earnings”. That’s ultimately what the stock market is priced on. What companies earn, times by a multiple of those earnings. That’s how you attempt to figure out what fair value is. 

Now on the positive side. When the economy comes out of a recession, earnings tend to be understated, meaning we are usually raising the estimate of earnings as companies often beat their revenue and profit forecasts as they report. And that figure, I believe, is historically around 10%. Therefore, it becomes a bit of a wash. Furthermore, when there are limitations on profits before taxes hit, it’s not uncommon to find companies reinvest in their business, by building a new plant, R&D, increase salesforce, which will ultimately be good for future earnings.

The last point I will say on all of this is, that whatever it becomes, by the time it happens, the market has already priced it in. The fact we are discussing it means its already priced in now. Sure, it’s a headwind, sure there is potential for volatility, but the beauty of capitalism is, if the door is closed, jump out the window. CEOs will find ways to make money, they just need to know what the playing field looks like.

With that said, here’s the buy/sell.

PS. Here’s a really cool two-page tax guide that I have on my desk. It’s very helpful.

2021 tax planning guide (jhannuities.com)

Mick Graham, CPM®, AIF®

Branch Manager/Financial Advisor at Raymond James in Melbourne, FL

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any opinions are those of Mick Graham and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation. While familiar with the tax provisions of the issues presented herein, Raymond James financial advisors are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.

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