Following the passage of the $ 1.9 trillion stimulus package, which included the $ 1,400 stimulus check under the Biden administration, Wall Street expects a tax hike for the U.S. economy. A fierce stimulus has increased expectations that US President Joe Biden’s other proposals will go into effect at the time of the election campaign. Among many agendas, Biden had plans for tax increases.
The president plans to raise the corporate tax rate from 21% to 28%. He also suggests imposing a minimum tax rate of 15% – a potentially damaging result for some large, low-tax companies. And this new bill could be seen as the first federal tax hike in nearly three decades, as the new tax law is expected to provide for an increase in corporate tax and an increase in the tax rate on investment income.
How worrisome is it?
First and foremost, the centrist Democrats in Congress reject Biden’s corporate tax proposal, which is why Goldman Sachs strategists forecast this week that the corporate tax rate will rise to just 25%, below the 28% proposed by Biden, according to barrons.com.
Regarding capital gains tax, Biden’s proposal would require those earning $ 1 million or more annually to levy capital gains tax on stocks at 39% – the normal income tax rate – versus the current capital gains tax rate of 20%. There is talk of there being resistance from the centrist democrats that could bring the actual rate well below 39%.
An increase in capital gains taxes means a lukewarm Wall Street in the short term
An increase in capital gains tax could lead to a large-scale sell-off of stocks, according to economic research, as indicated on CNBC. In 1986, the maximum rate of capital gains under the Reagan Tax Plan increased from 20% in 1986 to 28% in 1987. Just before the increase, realizations of capital gains increased 60%, according to the CNBC article. A general sell-off in the stock markets means a short-term difficult situation for companies like iShares Core S&P total US equity market ETF ITOT.
The story goes on
However, the increase should not have any impact on the markets in the long term. An increase in capital gains taxes would certainly have an impact on stock market valuations. Investors may only be willing to pay a lower multiple for short-term gains as the after-tax return would be lowered according to the article on barrons.com. However, this should not suppress all market momentum.
In 2013, the S&P 500 grew by around 30% despite the nine percentage point increase in the withholding tax rate. In 1981 the tax rate dropped eight percentage points, but the S&P 500 slipped 10%, according to Barrons’ article.
With this in mind, we expect the medium to long-term bet on the S&P 500 ETFs to be worthwhile. With virus cases rising in the US and elsewhere and the economic reopening slowing, the S&P 500 stocks seem like better bets than the domestically focused small-cap Russell 2000 index.
Also, small businesses that are more domestically focused and less overseas pay huge taxes in America. This is because these pint-sized companies cannot stack cash in foreign countries. As a result, the segment could fall victim to Biden’s anticipated tax plan (see: ETFs On Risks If Tax Law In The US Changes).
Meanwhile, the tech-heavy Nasdaq suffers from overvaluation concerns. Therefore you can place bets on the S&P 500 ETFs mentioned below at the current level. Wall Street bull Ed Yardeni sees the S&P 500 year-end target at 4,300, indicating an 8% gain from Friday’s close. In 2022, the figure is 4,800, as reported on CNBC.
ETFs in focus
Vanguard S & P 500 ETF (FLIGHT)
iShares Core S & P 500 ETF (IVV)
SPDR S & P 500 ETF Trust (SPY)
SPDR Portfolio S & P 500 Growth ETF (SPYG)
SPDR Portfolio S & P 500 Value ETF (SPYV)
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