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Earnings hit from Biden tax hike seen offset by stimulus if Dems sweep Congress


According to Market Intelligence, February 2023


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Earnings hit from Biden tax hike seen offset by stimulus if Dems sweep Congress

Democratic presidential nominee Joe Biden's plan to raise corporate tax rates should he win the White House might not be so bad for the stock market, as long as Democrats gain control of both houses of Congress as well.

That would allow him to push through a larger stimulus bill than is likely under either a second term for President Donald Trump or a split Congress alongside a President Biden, economists and analysts told S&P Global Market Intelligence.

Estimates for the effect on S&P 500 earnings of Biden's campaign pledge to partially undo President Trump's 2017 corporate tax cuts range from negative 5% to negative 9%.

However, once the proposals are pared down through legislative attrition and his $7 trillion of spending plans are taken into account, the hit to earnings per share would be blunted, with some even seeing a better outcome for stocks under Biden.

The cornerstone of Biden's tax policy is an increase in the corporate tax rate, which President Trump and the then-Republican-controlled Congress lowered from 35% to 21% as part of their federal tax overhaul passed in November 2017. Biden has proposed raising the rate from 21% to 28%, which the Committee for a Responsible Federal Budget said would raise corporate tax liabilities by as much as $131 billion per year, or more than $1 trillion over a decade.

Trump's planned tax policy centers on stopping his 2017 tax cuts from expiring as planned in 2025, though he has given little other detail.

"Biden's tax proposals could hit earnings per share. They could put a real damper on people putting money into the market," Mark Mazur, the Robert C. Pozen director of the Urban-Brookings Tax Policy Center, said in an interview. "But a Biden presidency is also likely to put a big round of stimulus up front, and that's going to push out any effects of his tax policy on the stock market."

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Biden's tax changes could cause S&P 500 earnings per share to dip by about 9% in 2021, with about half of that reduction due to the increase in the corporate tax rate, according to Ben Snider, an equity strategist with Goldman Sachs. The other half would come from Biden's plan to reduce a deduction for the foreign affiliates of U.S. companies, a minimum tax on global book income, and a proposal to hike payroll taxes on high earners, he said.

However, Goldman Sachs' U.S. equities team predicts that Biden's tax plans will be watered down as they pass through Congress and that the pared-down reform by itself would reduce S&P 500 EPS by approximately 5%. They also expect that the reforms will only begin to take effect in 2022, with the full earnings impact not being felt until 2023.

Moreover, once his spending plans have been taken into account, earnings per share would likely be marginally higher over the four years of a Biden presidency than under a business-as-usual scenario, said the Goldman Sachs analysts, who predict a compound annual growth rate of 14% through 2024, compared with 13% if tax and spending were to stay the same.

"There might be some kind of knee-jerk reaction in the stock market thinking that Biden is going to raise taxes on corporations," Nancy Vanden Houten, lead economist with Oxford Economics, said in an interview. "It's quite reasonable to assume there will be some changes, but [Biden’s] proposals have been well telegraphed, and markets are supposed to price in all the available information. No one should be surprised."

Winners and losers

Biden's plans would affect the economy unevenly, as some sectors benefited more than others from the 2017 tax cuts and so would be disproportionally affected by them rising again.

Industrials, technology, consumer discretionary and financials stocks were some of the biggest beneficiaries of Trump's 2017 tax cuts, according to asset manager Amundi Pioneer. Boeing Co.., for example, saw its effective tax rate reduced from 29% to 13% after the legislation, while Netflix Inc. had its effective tax rate reduced to 7% from 23%.

But while a higher statutory tax rate would likely create a headwind for the industrials, consumer discretionary and financials stocks that most benefited from the 2017 cuts, the combined impact of a corporate tax hike and increase in the global intangible low-taxed income, or GILTI, tax rate would hit communication services, healthcare and information technology hardest, said Goldman's Snider.

Biden's tax proposals could cost the 10 largest U.S. banks $7 billion per year, while the country's 209 publicly traded banks with at least three analyst estimates would see aggregate annual income reduced by $9.36 billion, according to an analysis by S&P Global Market Intelligence.

The impact on energy companies varies. The so-called upstream segment, mainly focused on exploration and production, cannot be taxed on what it does not earn, meaning it is insulated by a lack of profits and years of losses stored as future tax deductions. Midstream companies and utilities, meanwhile, have a buffer because they pass on tax expenses to other entities and deduct accelerated depreciation of their pipes and other hard assets.

A reversal would present a unique challenge for utilities, though, as increased tax costs would be borne by ratepayers at the same time regulators try to keep electric and gas rates low amid the economic fallout from the COVID-19 pandemic.

The corporate tax rate increase would likely hit domestic-focused companies who most benefitted from the 2017 cut, wrote Daniel Grosvenor, director of equity strategy at Oxford Economics. But international stocks will be exposed to Biden’s proposals to reduce the GLITI deduction for U.S. companies' foreign affiliates to 25% from 50% and apply a minimum 15% tax to the global book income of U.S.-based companies.

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The impact of Biden's spending plans are also likely to be uneven, economists said.

"At this point, we're not convinced that this spending package would be any larger or smaller than one under a second term with Trump as president, but the allocation of funds certainly would be," said Matthew Weller, global head of market research at GAIN Capital. "In the case of a Biden victory, 'clean energy' and infrastructure stocks could be among the bigger winners."

Ultimately, the impact will be determined by what Biden gets through Congress in the event of a victory in November.

'Day one'

Biden has said he would enact his tax plans on "day one" of his tenure in the White House. However, some economists said that he would likely pare back the scope and timing of his tax policy proposals, softening the potential hit to equity markets and the broader domestic economy.

"He's not going to inherit a real strong economy," said Mazur from the Urban-Brookings Tax Policy Center. "So it's really hard to tell yourself that the first thing you're going to do is raise taxes. If Vice President Biden gets elected, he's going to have to rethink his economic plan a bit."

In addition, Biden's tax hike would keep corporate tax rates below where they have historically been.

"None of the things that Vice President Biden has been talking about are so far afield from things that we’ve seen in the past," said Mazur. "If Biden gets elected, the corporate tax rate will be 7 percentage points lower than it was in the 1990s. So I think you don’t want to overreact to this."