In just over five weeks, voters will go to the polls or mail in their ballots to determine which path our great country will take over the next four years.
Although there are aspects of tax governance that have nothing to do with Wall Street, some of the laws made on Capitol Hill by elected officials do have a relationship with American companies and/or taxpayers.
Arguably the biggest question for Wall Street and the investment community is what might happen to corporate tax rates. While former President Donald Trump’s landmark Tax Cuts and Jobs Act permanently reduced the corporate tax rate from 35% to a historically low 21%, current Vice President and Democratic Party presidential candidate Kamala Harris has proposed increasing the corporate tax rate by a third to 28%. to generate additional income.
The million-dollar question is: will raising the corporate tax rate by 33% cause stocks to crash? For this answer, I’ll let history do the talking.
Kamala Harris Aims to Raise Corporate Tax Rate by 33%: Should Investors Worry?
Before delving into what history has to say about past cases of corporate tax increases and stocks’ response, it’s important to understand the “why” that compels Harris to propose raising corporate taxes.
With the exception of 1998 to 2001, the US federal government has spent more than it has generated in revenue every year since 1970. These nominal dollar deficits have ballooned in the last two decades, following the dot-com bubble, the financial crisis and the COVID-19 pandemic. In 2023, the federal deficit approached $1.7 trillion, which has increased the US national debt to around $35 trillion.
The cost of paying off and sustaining our national debt is rising at a worrying rate and is simply not sustainable in the long term, requiring proposals from elected officials, including presidential candidate Harris, to increase revenues and/or cut spending.
Harris’ plan to raise the corporate tax rate to 28% would play a vital role in increasing federal tax revenue by about $4.1 trillion between 2025 and 2034, according to an analysis by the Tax Foundation, a think tank. experts based in Washington, DC. Note that this estimate includes the entire Harris tax proposal and is not based solely on the corporate tax increase.
Raising the corporate tax rate, on paper, would seem like bad news for businesses. A higher tax rate would be expected to leave less revenue for hiring, acquisitions and innovation. But what makes sense on paper doesn’t always translate to the real world.
A Fidelity study analyzed the impact of three separate types of tax increases (personal, corporate and capital gains) over a period of about seven decades, beginning in 1950. In total, Fidelity analysts examined 13 separate years in which at least At least one of these types of taxes increased and took into account the performance of the benchmark index. S&P 500 (SNPINDEX: ^GSPC) in the preceding calendar year, during and after the tax change in question was made.
There have been five instances since 1950 in which the corporate tax rate was increased: 1950, 1951, 1952, 1968 and 1993. The annual price return of the S&P 500 in these years, according to Fidelity, was 22%, 16%, 12%. , 8% and 7%, respectively. On average, the S&P 500 has cattle 13% when the corporate tax rate rises.
While history can be fallible and no metric is infallible when it comes to predicting the short-term future, corporate tax increases have correlated positively for stocks 100% of the time since 1950.
There is a greater concern about stocks and it has nothing to do with Harris or Trump
While investors shouldn’t worry too much about the prospect of a corporate tax increase if Kamala Harris wins in November, this doesn’t mean the stock market is in good health.
Regardless of who claims the Oval Office in January 2025, Kamala Harris or Donald Trump, they will inherit one of the most expensive stock markets in history.
Thanks to the rise of artificial intelligence (AI), stock split euphoria, and overall corporate earnings exceeding Wall Street’s moderate expectations, we’ve witnessed the iconic Dow Jones Industrial Average (DJINDICES: ^DJI)Widely followed by the S&P 500, and growth driven by stocks Nasdaq Composite (NASDAQ INDEX: ^IXIC)reach multiple all-time highs in 2024. But the broadest of these three indexes, the S&P 500, is making noise for the wrong reasons.
Although “value” is in the eye of the beholder, the Shiller price-earnings (P/E) ratio of the S&P 500, which is also known as the cyclically adjusted price-earnings ratio (CAPE ratio), has an effect remarkable. Good job detailing how outsized valuations are right now compared to 150+ years ago.
The P/E ratio is probably the most well-known investment metric. Divide a company’s share price into its trailing-12-month earnings per share (EPS) (TTM) to get a figure that can be compared to peers, the broader market, and history to determine whether a company is relatively cheap. or expensive.
Meanwhile, Shiller’s P/E ratio is based on average inflation-adjusted EPS over the trailing 10 years. The advantage of analyzing 10 years of inflation-adjusted EPS data compared to TTM EPS is that it smoothes out shock events (e.g., the COVID-19 pandemic) that can easily throw off short-term valuation measures like the Traditional P/E. relationship.
When the closing bell rang on September 26, the S&P 500’s Shiller P/E was at 36.9. This roughly matches its high for the current bull market rally and is more than double the average reading of 17.16 when backtested to January 1871.
What’s more concerning is how stocks have reacted after the previous five instances where the S&P 500’s Shiller P/E surpassed 30 during a bull market. While there is no rhyme or reason to how long valuations can remain stretched, the S&P 500, the Dow Jones Industrial Average, and/or the Nasdaq Composite have all eventually (keyword!) lost between 20% and 89% of its value after these events.
There have only been two other periods in 153 years (before the dot-com bubble burst and in late 2021/early 2022) when stocks have been more expensive than they are now.
Although history is not repeated verbatim on Wall Street, it often rhymes. Whatever happens on November 5, current stock valuations should be the biggest concern for investors.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Will Kamala Harris’ Plan to Raise the Corporate Tax Rate by 33% Cause Stocks to Fall? The story couldn’t be clearer. was originally published by The Motley Fool