Biden’s Tax Increases Won’t Affect Just the Top 1%
On March 31, 2021, the Biden administration introduced the American Jobs Plan, which, proposes a series of increases in corporate and individual tax rates to pay for a massive new infrastructure bill. Despite claims that the proposal’s tax changes would impact only the top 1% of taxpayers (or less), evidence and economic intuition strongly suggest otherwise.
Biden’s American Jobs Plan
On March 31, 2021, the Biden administration introduced the American Jobs Plan, which proposes a series of increases in corporate and individual tax rates to pay for a massive new infrastructure bill. Among other things, the administration proposes to increase corporate taxes from 21% to 28%, increase the top capital gains rate from 23.8% to 43.4% for incomes over $1 million, and increase the top individual income tax rate to 39.6%. 
Despite claims that the proposal’s tax changes would impact only the top 1% of taxpayers (or less), evidence and economic intuition strongly suggest otherwise. To the contrary, the proposed tax changes would almost certainly lead to lower stock prices and ensnare millions of US households over time.
Corporate Income Taxes
While the proposal’s advocates argue the bill would impact only a very small percentage of Americans, the reality is that 55% of Americans own stock  not to mention the many thousands of public and private pensions plans, educational institutions, and other non-profits that own stocks in their portfolios. Regardless of what one might believe about the relative merits of the proposal, there’s no escaping the fact that any increase in corporate taxes would likely have negative implications for everything from the funding of public pensions (a decline in asset values requires greater contributions from taxpayers) to student financial aid (smaller endowments means less student financial aid) to the retirement security of many households (the 55% of households that own stocks). These are all very real, second order effects of a decline in stock prices due to rising corporate tax rates.
What investors ultimately want to know is the degree to which equity markets might decline should the proposal become law. In theory, a 33% increase in corporate taxes from 21% to 28% means corporations must hand over an additional 9% of their current pre-tax income to the federal government (see Exhibit A). Consequently, given stock prices are ultimately a function of companies’ earnings, on this premise alone stock prices could fall 8.9% should the proposal become law. Whether one deems such a decline to be material or not is naturally a subjective determination, but there’s no mistaking the direction: higher corporate taxes, all things equal, result in lower stock prices.
Consider Exhibit A. Under current law, companies in theory keep $0.79 for every $1 in pre-tax earnings. Should the administration’s proposal become law, companies would keep $0.72 of each dollar in pre-tax earnings (a decline of 8.9%). At a multiple of 22 times earnings, this implies an S&P 500 valuation of about 3,855, down 8.9% from where it closed on April 30, 2021. But markets are complex and there’s certainly no guarantee market declines would stop there. For example, it’s perfectly conceivable that, in response to higher corporate taxes, markets might decide to price earnings at something less than 22 times earnings to reflect higher tax and regulatory risks. That would result in still further declines in equity values. For example, should taxes rises and markets decide to price the S&P 500 at 18 times earnings—still higher than the index’s long-term average of 16 times earnings—the index would fall approximately 25.4% from its close on April 30, 2021.
Exhibit A: Impact of Corporate Tax Increase from 21% to 28% 
|Earnings Before Tax||$1.00||$1.00||–|
|Corporate Tax Rate||21.0%||28.0%||33.3%|
|Net Income ($1 after after tax)||$0.79||$0.72||-8.9%|
|S&P 500, implied valuation @ 22x||4181||3811||-8.9%|
|S&P 500, implied valuation @ 18x||N/A||3118||-25.4%|
Finally, increasing the corporate tax rate to 28% puts it solidly above the OECD average of 23.85%.  Subsequently, raising the U.S. corporate tax rate to 28% would, at least to some degree, add to incentives for U.S. domiciled corporations to relocate to lower tax jurisdictions. While those considerations are often complex and multidimensional, this is nevertheless a very real challenge in an interconnected global economy—one that’s increasingly dominated by virtual meetings powered by Zoom and other work from home technologies. But the world is similarly flat for manufacturers. For example, in 2017 and 2018 and Trump administration-imposed tariffs on Chinese imports, an ill-conceived and poorly designed policy that was designed to incentivize China-based manufacturers to relocate to the United States. Only they didn’t. They instead relocated to other countries in Asia, notably Vietnam, to avoid US tariffs while still capitalizing on Asia’s low labor costs. 
Impact on Corporate Dividends
There are also negative implications for corporate dividends. According to one study, more than 25 million taxpayers reported dividend income in 2012—63% of them over the age of 50.  Another study found that 17% of U.S. households receive dividends.  How might increases in corporate taxes negatively impact recipients of dividend income? For starters, an 8.9% decline in earnings after tax means less earnings available for dividend payments. Companies with already low dividend coverage ratios (a measure of their ability to pay dividends) may elect to reduce or even suspend dividend payments. A less draconian possibility is that companies may elect to suspend planned future increase in dividend payments. Finally, the tax rate on their dividends will increase from as low as 15% under current law (ignoring the 0% bracket) to as high as 43.4%–a 189% increase.
However, the above analysis notwithstanding, the real world is rarely so simple. This is especially true in financial markets, where many factors influence stock prices and dividends—taxes being just one of those. And in truth, the corporate tax rate matters less than the method by which taxes are calculated. For example, while the administration proposes to increase the statutory corporate tax rate to 28%, few companies actually pay that, thanks in part to a labyrinthine tax system that’s riddled with numerous deductions, credits, and other tax loopholes. For the quarter ending March 31, 2021, the effective corporate tax rate for S&P 500 companies was 17.95%;  and 55 companies, all of them constituents of the S&P 500, actually paid zero federal income taxes in 2020.  The real question, ultimately, is what the administration proposes to do with respect to how corporate taxable income is calculated and less so what rate to apply to the product of those calculations.
Capital Gains Taxes
The top capital gains rate is currently 20%. Add to that the Net Investment Income Tax (NIIT) of 3.8% for households earning more than $250,000, and the top capital gains rate quickly rises to 23.8%. The administration proposes taxing capital gains as income for households with income greater than $1 million. Given that it also increases the top marginal income tax bracket to 39.6%, the proposal would effectively increase the capital gains rate to 43.4% (39.6% + 3.8% NIIT). I should also note that the NIIT “threshold amount”—the $250,000 in adjusted gross income where the NIIT kicks in—isn’t indexed for inflation. In practice that means the 3.8% NIIT applies to more taxpayers every year due to inflation alone, which is certainly more material today than in years past. 
Promoters of the proposal argue that the higher capital gains rate would apply only to the top 1% of taxpayers or less. However, this claim ignores a sobering reality: it would apply to far more households over time because the top 1% of households isn’t a static, fixed number of households. Who’s in the top 1% changes all the time. Said differently, there is considerable migration in and out of the top 1%, 5%, and 10% of households. Consider the evidence. According to research conducted by Professor Mark Rank of Washington University in St. Louis and Professor Thomas A. Hirschl of Cornell University: 
- 12% of Americans find themselves in the top 1% at least once in their lifetime
- 39% of Americans find themselves in the top 5% at least once in their lifetime
- 56% of Americans find themselves in the top 10% at least once in their lifetime
- 73% of Americans find themselves in the top 20% at least once in their lifetime
These findings are unsurprising to anyone who works in wealth management or any of its related disciplines like law or tax accounting. Many households experience episodic windfall events over their lifetime. For some it’s the exercise of incentive stock options earned over many years, the reward for many years of loyalty and hard work. For others, it’s the sale of a family business nurtured over many generations while for others it might be the sale of a dental practice upon retirement. Even something as innocent as the forgiveness of debt, a taxable event, can result in reported income exceeding $1 million. The takeaway is that these are most often episodic, non-recurring events that represent the realization of value created over many years, often decades. Many of these events temporarily push household incomes above $1 million, taxing a lifetime of toil all in a single year and at the highest marginal rates.
There are at least several takeaways for investors from the administration’s proposed tax increases.
- You’re probably not immune. The administration’s tax proposals would likely impact the incomes and retirement security of millions of U.S. households and institutions over time. Perhaps not every year, but certainly over time, the accretive impact of the bill’s tax increases would be substantial.
- Now is the time to prepare. Yes, there’s a relatively low probability that the proposal, as written, becomes law. But then again, stranger things have happened inside the Beltway. With a projected $3.4 trillion deficit for 2021 and mounting federal spending proposals, it’s probably not wise to play chicken with tax rates. Plan now or pay later.
- Tax management is wealth management. Whatever superficial barriers existed between tax planning and other wealth management disciplines have disappeared. Taxation, in all its forms, has always presented a very real existential threat to families’ financial security; that’s more apparent today than at any time in recent memory. Working closely with a multidisciplinary advisory team, one with deep tax expertise, is absolutely critical to successfully navigating the perilous waters that lay ahead.
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 “FACT SHEET: The American Jobs Plan,” whitehouse.gov, 3/31/21.
 Stock Market,” news.gallup.com.
 Source: YCharts, Inc.
 Calculations by the author. Assumes market valuation at 22 and 18 times forward earnings.
 Asen, Elke. “Corporate Tax Rates Around the World, 2020”, Tax Foundation, December 9, 2020.
 “US Tariffs Drive Drop in Chinese Imports,” The Wall Street Journal, May 12, 2021.
 “Dividend Tax hike Will Hurt Millions of Americans at All Income Levels,” Edison Electric Institute, Thursday, July 12, 2012.
 Burman, Leonard and Gunter, David. “17 Percent of Families Have stock Dividends,” Tax Policy Center. May 2003.
 CSI Market (www.CSIMarket.com)
 Beer, Tommy. “More than 50 Major US Corporations—Including Nike and FedEx—Paid No Federal Taxes Last Year,” Forbes. April 2, 2021.
 Year-over-year inflation for April 2021 rose to 4.2% from a year ago. Source: Bureau of Labor Statistics.
 As quoted by Mark J. Perry in “Some amazing findings on income mobility in the US,” American Enterprise Institute, November 16, 2017.
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