Why hike rates when you can hike taxes?
The market has been trained to fear rate hikes.
When rates go up or a hike is foreshadowed, that's the time to sell stocks. It's been the rule-of-thumb for ages.
What's less reflexive is what to do when taxes go up. That's a more-complicated question but it's certainly not a positive for stocks if corporate tax rates go up.
What makes it a difficult trade is that it's been so long since it happened. US tax rates haven't gone up since 1993 when the top rate went to 39.6% from 31%. The corporate rate for income above $15m also went to 38% from 34% for income above $15m.
Since then, it's been a slow series of tax cuts with the corporate rate chopped down all the way down to 21% under Trump.
Interestingly, one of the arguments made at the time of the Clinton tax cut was that by taming the deficit, it would encourage Federal Reserve Chair Alan Greenspan to cut, which, along with increased confidence among investors, would lead to an improving economy.
This time, there's a riff on the same argument. By raising taxes, there will be some economic tightening, which will prevent the Federal Reserve from having to hike interest rates.
Bloomberg today highlighted some of the tax plans under consideration, citing people familiar:
- Corporate tax rate to 28% from 21%
- Paring back preferences for pass-through businesses
- Raising tax rates on those earning +400K
- Expanding the estate tax
- Higher capital gains for those earning at least $1m annually (possibly at income tax rates)
These were all things Biden proposed on the campaign trail so they shouldn't be a huge surprise.
However the market hasn't likely priced much of it in because it will take a bi-partisan deal to avoid the Senate filibuster and half of Congress has been bought off.
This will be a very tough one to navigate but Biden is likely going to push it sooner than later because Yellen is no-doubt telling him that the timeline for Fed hikes is moving closer.
In terms of FX, a looming corporate tax hike risk is going to raise the preference for non-US equities and that should be a drag for the dollar but right now that's overwhelmed by positive reopening news.
The plan from the White House is probably to push this through. The effect would be a lower dollar via the equity channel but also because it would cause a repricing lower on Fed expectations. Those lower Fed expectations and weaker dollar would then add to growth, leaving the US net stronger in terms of GDP and the deficit.
Of course, every perfectly-laid plan finds a way to go off the rails.
