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.
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.
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.
|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. 
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.
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: 
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.
 “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.
Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control.