Uncle Sam in the Spotlight

uncle sam pointing his finger out of the american flag

July 13, 2021

To watch/listen to this week’s article please click here.

The next agenda item on the Biden Administration will be taxes. This will undoubtedly be a topic that gets A LOT of headlines, and sure to get your attention. No one likes paying taxes, and everyone I talk to believes that higher taxes will correlate to smaller equity market returns or even stock market losses.  Income taxes are one thing, but a hike in capital gains taxes is viewed by most people (and every TV commentator) as the pin that will bust the bubble. We will dig a little deeper.

First, let’s look at what is being proposed right now. I highlight proposed because we are not even in the negotiation phase yet. We are in the “let’s gather public support phase”. As we all know, the GOP will push back hard on any tax hikes for individual rates, and specifically cap gains rates. So, this fight is sure to drag out for a while and take up a lot of column inches.

The White House released the “Green Book” which provides some deeper details from the Treasury Department on the administrations tax and revenue proposals. The high points include:

  • Changing the top tax bracket from 37% to 39.6%
  • Increase the corporate tax rate from 21% to 28%
  • Adjust the Global Tax rules from 10.5% to 21%
  • Eliminate the Capital Gains Tax Rate for Adjusted Gross Incomes more than $1 million

On the surface it looks like a deterrent to economic growth. Markets love liquidity and if some is being taken out of the system then the effect on market returns should be negative, correct? Well, let’s take a look at the last few hikes. 

2012/2013

The Obama administration lifted the Cap Gains rate on incomes above 250k from 15% to 20%. In addition, a new 3.8% surtax on investment income earned in households earning over 250k.

Tax Reform Act of 1986

A Capital Gains Tax hike from 20% to 28% went into effect on January 1st, 1987. Eight months after this hike the market experienced a one day drop of 20%, known today as “Black Monday”.  (Although in Australia we call it Black Tuesday, because we are a day ahead – fun Dad fact there). This crash had nothing to do with the tax hikes but was attributed to computer trading glitches and subsequent panic selling.

I could go on to show you the opposite. Tax cuts and subsequent market returns, and they would give you the same result. Being that there is truly no correlation between stock market returns and tax cuts or hikes. From my perspective the reason is twofold.

  1. Now I’m guessing, however, I would suggest that around 75% of all invested assets are owned by institutions and/or retirement accounts and pension plans, who don’t experience the effects of tax changes as much as individuals.
  2. Market returns are ultimately driven by corporate earnings. Yes, a tax hike reduces the amount of net profit a company produces, however a CEO of a company will maneuver the company in a way to provide maximum return to the shareholders over time. Invest in R&D, move offshore. etc. The bigger issue than what the tax rate is currently at, is the uncertainty about what the tax rate will be. Uncertainty spooks the market, the rest we can manage around.

In summary, for most of us the changes will be negligible. For those that will be affected (incomes over $1 million), then there will be some tax planning that will need to be done. So at least we now have a range of where taxes will be, likely somewhere between where it is now and the President’s wish list.

I’m attaching a graph I ran this week showing what I think is pointing to some shorter-term market fatigue. Will give you more info in the video. With all that, here’s the buy/sell.

Mick Graham, CPM®, AIF®

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

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