With his first 100 days as president now officially in the books, we’re starting to see Joe Biden leave his mark on the U.S. political agenda.

On one hand, with a nod to the obstacles he faces in the Senate, Biden has turned to a record number of executive orders to influence directive. These include targeted measures on climate change and actions to control the pandemic. In addition, the Biden administration has leveraged its political backing into stimulus measures aimed at boosting the economy, creating jobs and helping Americans return to work. These include:

  • The $1.9 trillion American Rescue Plan Act of 2021. The relief package was signed into law in March and included direct payments to most Americans and an extension of increased unemployment benefits.
  • A proposed $2 trillion targeted at infrastructure improvements.
  • A proposed $1.8 trillion for family related programs such as child care, education and paid leave.

Of course, these increased spending measures lead to the inevitable question of how they will be funded. To this end, the Biden administration has proposed several tax increases. Notable items include:

  • An increase in the corporate income tax rate to 28 percent.
  • Specific measures to target multinational corporations, specifically those with a lot of intellectual property in foreign countries. These measures are expected to most heavily impact the technology and health care sectors, as well as the likes of Facebook and Google in the communication sector.

Amidst ongoing political jockeying, we still don’t know what the final word will be. Tax increases seem fairly likely, though not guaranteed. The Democratic majority is razor-thin in the Senate and not exactly huge in the House of Representatives. As such, some of the proposed tax increases are likely to be watered down.

Taxes and the markets

With this lingering tax uncertainty, it’s easy to see how a potential increase in corporate taxes–and subsequent reduction in the share of earnings available to shareholders–could be a negative development for the stock market. Yet, the complexities of financial markets make it difficult to draw such linear conclusions.

For context, we can look at the reaction of stocks to instances of tax increases in the past. As outlined below, U.S. equity markets have exhibited an ability to remain resilient through all but one of the 13 instances of tax increases since 1950.

Equity returns in years with tax increases
S&P 500
Increase in:1950195119521968196919701971197219761987199119932013
Personal tax X X X X             X X X
Corporate tax X X X X               X  
Capital gains tax       X X X X X X X X X X

Source: Macrobond, RBC GAM. Data as of Dec. 31, 2020. S&P 500 TR Index (USD). An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results.

Key takeaways:

  • These results do not suggest markets prefer tax increases. Rather, they indicate that markets have historically been able to look past tax increases because of other factors at play. These include elements such as economic growth, government stimulus, support from central banks, and investor sentiment.
  • Likewise, in the current environment, the proposed increase in corporate taxes could be a potential headwind on profits. However, with vaccinations progressing and economic activity ramping up, tax increases could prove to be relatively minor compared to the massive gains in expected profits.

We recognize that valuations in pockets of the U.S. equity market are demanding. Undoubtedly, strong profit growth will be required to support these prices. However, for those concerned that a potential increase in corporate taxes will be the straw that breaks the camel’s back, history provides a compelling counter-argument. Rather than focusing on any one policy item, it’s important for investors to have a plan in place that they can stick with in the long run. Taxes et al.

An investment cannot be made directly into an index. The above does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results.

This has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only, as of the date noted only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when provided. Past performance is no guarantee of future results. Interest rates, market conditions, tax rulings and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. You should consult with your advisor before taking any action based upon the information contained in this document. Information obtained from third parties is believed to be reliable but RBC GAM and its affiliates assume no responsibility for any errors or omissions or for any loss or damage suffered. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.

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Publication date: May 20, 2021

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