Are taxing times ahead for US equities?

01 October 2021

By Julien Lafargue, CFA, London UK, Chief Market Strategist

You’ll find a short briefing below. To read the full article, please select the ‘full article’ tab.

  • Summary
    • US President Joe Biden is proposing tax increases for wealthy Americans and big corporations – but should investors be worried?
    • The moves will reverse some of the Trump administration’s tax cuts. But the real question is how much of Biden’s tax plans will make it through Congress, given the razor-thin Democrat majority
    • Analysts are still unsure how the potential tax changes will play out. The prudent approach may be to wait and see rather than shifting investments in anticipation of any changes
    • In the current climate, we believe that peak growth rates for US corporate earnings are behind us and that valuations will struggle to expand over the rest of the year
  • Full article

    Higher US corporate taxes seem on the cards as Democrats advance infrastructure spending plans. Are US equities about to suffer as a result and should you adjust equity portfolios?

    The Biden administration in the US has made clear that any large-scale infrastructure spending would likely be financed by higher tax rates. With the Democrats trying to advance their political agenda, should investors worry about a possible corporate tax rate hike?

    Higher taxes on the horizon

    A hike in American taxes looks likely soon, but there is no certainty as to what they would look like. Back in 2017, President Trump cut the US statutory corporate tax rate to 21% from 35%, the highest in the OECD. Current discussions seem to place a revised tax rate in the 25% to 26.5% range, taking away less than half of the deductions introduced four years ago.

    For individuals, according to the Democratic proposal, the top marginal income-tax rate may return to 39.6% with a new 3% “surtax” potentially levied on incomes greater than $5 million. On the other hand, the long-term capital gains tax rate would be set at 25%. These, combined with the existing 3.8% investment-income tax and the surtax, would yield a top individual marginal tax rate of 31.8% at the federal level.

    Companies would also face higher taxes on their foreign income with the minimum rate going up from 10.5% to 16.6%, although this would be offset by greater ability to offset foreign tax credits.

    Assessing the impact

    The Democrats’ razor-thin majority in the Congress means that any plan is likely to be subject to difficult negotiations and the end result could diverge widely from these opening bids. Nevertheless, the most probable outcome is that taxes, both for corporates and individuals, will rise in the short term.

    However, any change in the tax code would most likely happen as part of a broader $3.5 trillion reconciliation bill and therefore be, at least in part, offset by increased government spending. As a result, it is extremely difficult to assess the ultimate net impact of the proposed legislation.

    Estimates vary widely

    Because of the tedious negotiating process in Washington and the various proposals being floated around by both sides of the aisle, analysts and investors are struggling to model the ultimate impact of proposed tax changes on markets.

    At the corporate level, the consensus seems to range from a “worst-case” scenario of an eight percentage point headwind to S&P 500 companies and a “best case” scenario of a mid-single digit hit. Yet, as was the case for the Trump tax cuts (see chart), we would expect analysts to wait until the proposal becomes law before updating their numbers.

    Statutory versus effective

    One other reason why modelling the impact of changes in the tax code is so difficult is the number of tax breaks that allow companies to lower their effective tax rate.

    In fact, the majority of S&P 500 companies’ most recently reported effective tax rates were below the 21% statutory federal rate. As such, a 5% increase in the tax rate is unlikely to translate into a 5% downgrade in earnings. Similarly, the impact would vary sector by sector and company by company.

    A 5% increase in the tax rate is unlikely to translate into a 5% downgrade in earnings. Similarly, the impact would vary sector by sector

    Second round effects

    Last but not least, in order to properly assess the impact of higher taxes, the second round effects must be considered. As mentioned previously, the Biden administration’s plan is challenging in that it combines a change in both corporate and individuals tax rates while increasing government spending. This may create offsetting factors, all with different timeframes.

    For example, higher capital gains taxes could discourage some investors and weigh on stocks’ valuations while infrastructure spending may boost long-term growth prospects. Similarly, improved paid family leave and childcare might boost productivity, though this would be negated if lower corporate profits reduced companies’ ability to boost capital investments.

    Wait and see

    With all this uncertainty, the prudent approach is to wait and see rather than shifting portfolio allocation in anticipation of any potential tax changes. While we can establish that tax rates are likely to rise in the US and market participants haven’t seemed too worried about this until recently, the rest remains speculation at this point. In addition, the macroeconomic landscape (the outlook for inflation, COVID-19 and central bank policy) is likely to have a much larger influence on markets.

    As such, we maintain our view that US earnings growth will slow and that valuations will struggle to expand over the rest of the year. This should translate into more modest upside at the index level and higher volatility overall.

    We maintain our view that US earnings growth will slow and that valuations will struggle to expand


Market Perspectives October 2021

Our investment experts highlight our main investment themes, looking at how investors can play their part in tackling climate change, if proposed tax hikes might hit equity valuations, bonds fit for this stage in the credit cycle and whether surging energy prices threaten the economic recovery.

Related articles

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This communication:

  • Has been prepared by Barclays Private Bank and is provided for information purposes only
  • Is not research nor a product of the Barclays Research department. Any views expressed in this communication may differ from those of the Barclays Research department
  • All opinions and estimates are given as of the date of this communication and are subject to change. Barclays Private Bank is not obliged to inform recipients of this communication of any change to such opinions or estimates
  • Is general in nature and does not take into account any specific investment objectives, financial situation or particular needs of any particular person
  • Does not constitute an offer, an invitation or a recommendation to enter into any product or service and does not constitute investment advice, solicitation to buy or sell securities and/or a personal recommendation.  Any entry into any product or service requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding documents
  • Is confidential and is for the benefit of the recipient. No part of it may be reproduced, distributed or transmitted without the prior written permission of Barclays Private Bank
  • Has not been reviewed or approved by any regulatory authority.

Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.

Barclays is a full service bank.  In the normal course of offering products and services, Barclays may act in several capacities and simultaneously, giving rise to potential conflicts of interest which may impact the performance of the products.

Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.

Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation. Law or regulation in certain countries may restrict the manner of distribution of this communication and the availability of the products and services, and persons who come into possession of this publication are required to inform themselves of and observe such restrictions.

You have sole responsibility for the management of your tax and legal affairs including making any applicable filings and payments and complying with any applicable laws and regulations. We have not and will not provide you with tax or legal advice and recommend that you obtain independent tax and legal advice tailored to your individual circumstances.