The Biden administration is proposing higher taxes on capital gains.
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Investors are concerned about a more stringent tax regime under President Joe Biden. But when it comes to changes in the capital-gains tax rate, specifically, stocks are unlikely to be meaningfully affected.
Increased corporate and capital-gains tax rates could be on the way. Government spending hasn’t been light in the past year, with trillions of dollars of fiscal stimulus and potentially $2 trillion more for infrastructure spending. The federal government must find a way to finance that spending.
A higher corporate-tax rate would reduce earnings and, on its own, be a negative for stocks, though such a policy decision may not ultimately cause much harm. Centrist Democrats in Congress are also pushing back against Biden’s corporate tax proposal. That’s a key reason that Goldman Sachs strategists in March forecast that the corporate tax rate would rise to just 25%, below Biden’s proposed 28%.
The capital-gains tax is a separate concern. Under Biden’s proposal, as first reported by the New York Times this week, those earning $1 million or more annually would see capital gains on stocks taxed at 39.6% versus the current capital-gains tax rate of 20%. Nobody knows what the rate will end up being, but the same pushback from centrist Democrats suggests it could be lower.
In addition, history shows no discernible correlation between equity valuations and changes to the capital-gains tax rate. An increase in capital-gains taxes should lower an investors’ after-tax return and, in theory, would be reflected in stock-market valuations, or what investors pay for every dollar of profits. Investors may only be willing to pay a lower multiple for near-term profits, given that the after-tax rate of return would be lowered.
But that correlation isn’t visible. Research from UBS Global Wealth Management shows that earnings multiples on the S&P 500 can range from roughly 8 times to as high as over 20 times regardless of whether capital-gains taxes are at 15% or near 30%.
Indeed, there is “no relationship between capital-gains taxes and market returns,” writes David Lefkowitz, head of Americas equities at UBS. In 2013, for example, the S&P 500 gained 30% even though the capital-gains tax rate rose nine percentage points. In 1981, the tax rate fell about eight percentage points, but the S&P 500 still fell 10%.
The reality is that earnings growth and interest rates are the most important factors affecting stocks, which makes assessing the impact of tax rate changes on stocks difficult. One effect on the market, according to Arthur Weise, chief investment officer of Kingsland Growth Advisors, is that investors may gain interest in growth stocks over value stocks. The reason: Growth stocks benefit from longer-term industry changes, while value stocks are more impacted by the near-term movements of the economy, Weise says.
And holding a stock for that much longer would diminish any negative impact of a higher tax.
Write to Jacob Sonenshine at [email protected]
