US equity market remains unperturbed by the prospect of higher corporate taxes, with valuation multiples at record highs
The U.S. Federal Government budget deficit for fiscal year 2021 is expected under current law at -13.4% of GDP from -14.9% in 2020, according to the Congressional Budget Office (CBO). The deficit will narrow to -4.7% in 2022. As a result, the Federal debt is anticipated to remain at circa 100% of GDP (see graph below).
The Biden administration has put forward a bipartisan infrastructure plan of $579 billion (2.6% of GDP) in additional spending. The size of that framework corresponds to circa 55% of the size of the respective investment areas originally proposed under the Presidency’s American Jobs Plan.
Note that the proposed American Jobs Plan and the American Families Plan by the Biden administration, aim to increase spending and tax expenditures by more than $4 trillion over the next decade, albeit the final size will be subject to negotiation in the Congress. Democrats hold a slim majority of 220 seats versus 211(R) in the House (4 vacancies), whereas have taken narrow control of the Senate (50D-50R tie), with Vice-President Harris(D) representing the tie-breaking vote.
More importantly, the proposed post-pandemic plans would be partly financed by raising taxes on corporate profits, high income individuals and capital gains, as well as by providing the IRS the resources to address tax evasion. The American Jobs Plan aims to increase the federal corporate income tax rate from 21% to 28%, albeit it well remain well below levels (35%) which prevailed prior to the 2017 tax rate cuts.
A comprehensive bipartisan deal on the Presidency’s long term investment plans, remains very challenging. Legislation could also be passed in the Senate through the reconciliation process with only a simple majority, rather than the three-fifths majority often needed, which would allow it to take effect without Republican votes.
The Biden Administration has also endorsed OECD’s new two-pillar framework for international tax reform. The first pillar aims to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest Multination Enterprises. Under the first pillar, taxing rights on more than $100 billion of profit, are expected to be reallocated to market jurisdictions per annum.
The second pillar seeks to end the global race-to-the-bottom in corporate tax rates through the introduction of a global minimum corporate tax rate of at least 15%, generating circa $150 billion in additional global tax revenues per annum, or 63% of US corporate income taxes expected to be paid in 2021.
All told, there is a growing likelihood that the after-tax earnings power of US companies will be reduced, suggesting, ceteris paribus, a greater hit to equity sectors EPS with relatively lower effective tax rates (Technology, Communications and Health Care).
Short-term, the US equity market remains unperturbed by the prospect of higher corporate taxes. The S&P500 recorded new all-time highs in the past week (4352) with Technology (+15% ytd) leading the increase. US Banks lost ground (+25% ytd) due to lower long-term UST yields, while the Energy sector declined (+45% ytd), despite higher oil prices amid the Saudi-UAE clash (see Markets).