Benjamin Franklin once said, "In this world nothing can be said to be certain, except death and taxes." However, in a presidential-election year, you can pretty much take it to the bank that politicians are going to pitch tax reforms (cuts, hikes, etc., etc., and so forth) and oversell their plans' huge benefits. And, of course, hype the calamity that would ensue if their opponent’s plan is enacted. This year is no exception. Both Hillary Clinton and Donald Trump offer tax-change proposals as part of their platforms. Ditto for Libertarian Party candidate Gary Johnson and the Green Party’s Jill Stein. Many investors presume these changes—whether tax hikes or cuts—have a big impact on stocks. History, however, shows stocks typically don’t respond to tax law changes in a material way. And when they do, the reaction is frequently counterintuitive.
While it would be too cumbersome to fully detail each candidate’s plan here, we’ll offer you the highlights in a sort of Reader’s Digest fashion.
Trump is pledging to cut income taxes by collapsing the existing brackets from seven to three at slightly lower rates (12%, 25% and 33%). He proposes a large increase in the number of folks who aren’t paying any tax by quadrupling the standard deduction, and he would scrap the 3.8% Affordable Care Act surtax on investment income. His corporate-tax plan would cut rates by 20 percentage points (from 35% to 15%) and lower the tax on foreign-sourced profits to 10%, but forbid firms to defer taxation by holding funds offshore. He doesn’t propose changes to capital gains, although he does propose ending “carried interest”—the provision under which hedge-fund and private-equity-fund managers pay at capital-gains rates versus income-tax rates.
Clinton, by contrast, has said she aims to boost revenues by raising tax rates, primarily on higher earners. On income taxes, her plan calls for a 4% surcharge above existing rates for those with incomes in excess of $5 million. Those with incomes above $1 million would face a new 30% effective tax rate (a “Buffett Rule”). She would limit deductions and exemptions and raise the estate tax. She, like Trump, would end carried interest. For those with incomes below $750,000, tax experts estimate there would be little change. Capital-gains rates wouldn’t change, but qualifying for reduced long-term-gains rates would require a two-year holding period instead of one. She would keep the 3.8% surcharge on investment income that Trump would scrap. She hasn’t proposed any change to corporate taxes from present levels.
The Green Party’s Stein has provided few details of what her plan would exactly entail, but she has mentioned a financial-transaction tax of 0.5% on sales of stocks, bonds and derivatives. Further, she has, at times, claimed to favor eliminating reduced capital-gains rates altogether, although it isn’t clear that is part of her platform now. Her website and commentary claim she aims to rewrite the tax code to benefit lower earners more and tax higher earners more thoroughly. What that means in detailed terms isn’t made clear.
Libertarian nominee Johnson has the simplest plan (simplest to summarize, that is—not to enact): Eliminate all income, corporate and capital-gains taxes and replace them with a national consumption tax.
No matter who wins, it seems to us enacting these tax reforms ranges from “a smidge difficult” to “next to impossible.” Presidents cannot unilaterally change taxation—Congress has the power of the purse strings under the Constitution.
Presidents often promise big on taxes, only to find it slow going. On the campaign trail in 2008, then-candidate Obama promised to roll back the “Bush Tax Cuts” for higher earners. However, no legislation was enacted until 2013—despite his party controlling Congress in 2009 and 2010. When legislation finally passed, it was watered down significantly from campaign-trail talk. Similarly, George H. W. Bush famously promised “no new taxes,” only to enact new taxes. Talk is cheap. The current Congress spent most of the last decade arguing the US needs some kind of tax reform “Grand Bargain,” greatly simplifying the tax code. But while both sides agree reform is necessary, nobody can agree on exactly how it should look, which makes the “Grand Bargain” seem like the Loch Ness Monster of public fiscal policy.
This scenario is unlikely to change much when the new Congress is ushered in next January. Due to gerrymandering and incumbency, the Republicans likely will retain the House of Representatives at least. Democrats have a better shot at taking the Senate, but it won’t be easy. And, if they do take it, their majority will be razor-thin. Hence, it’s fairly unlikely Clinton’s plan will sail through to passage, should she win in November.
If Trump wins, he too could face a split Congress, if the Democrats take the Senate. But even if they don’t, that doesn’t mean Trump’s plan would be easy to pass. His proposals do not mesh well with the more traditional Republican platform on taxes. For one, many projects included in his plan would send deficits up substantially. Another: His plan to eliminate tax deferral on corporations’ foreign profits isn’t in keeping with Republicans’ or Democrats’ plans. It is unclear whether he would even have his own party’s backing.
As for Johnson and Stein, it’s incredibly unlikely they will win this election. But, if the miraculous happened and one of these third-parties took the White House, their plans would find little support. Johnson’s plan, a “Fair Tax” (as it has been dubbed—we don’t traffic in fairness), doesn’t have much Congressional support in either party. While we don’t know exactly what her re-write would be, Stein’s proposals, like the Financial Transactions Tax, have just about as little (if not less) support as the Fair Tax.
Many investors presume higher taxes—income, corporate, dividends or capital-gains—spell trouble for stocks. The logic: Less cash in consumers’ and corporations’ pockets gives them less firepower. Higher capital-gains or dividend taxes may reduce the attractiveness of investing in the first place. Lower taxes would do the reverse, so most investors might think markets would perform better if taxes were cut rather than raised. In theory, that makes a ton of sense. In practice, though, markets have historically adapted to tax-rate changes fairly easily. Exhibits 1-3 show historical changes to the highest tax bracket in income, capital-gains and corporate tax rates and the returns prior to and after the enactment of the tax change.
Exhibit 1: Income-Tax Changes and Stocks
Source: Global Financial Data, Inc., Internal Revenue Service, as of 09/16/2016. S&P 500 price returns, 12/31/1928 – 09/15/2016.
Exhibit 2: Capital-Gains Changes and Stocks
Source: Global Financial Data, Inc., Tax Foundation, as of 09/16/2016. S&P 500 price returns, 12/31/1953 – 09/15/2016.
Exhibit 3: Corporate Tax-Rate Changes and Stocks
Source: Global Financial Data, Inc., Internal Revenue Service, as of 09/16/2016. S&P 500 price returns, 12/31/1925 – 09/15/2016. Data are weekly from 12/31/1925 – 12/31/1927 and daily thereafter.
As shown, the enactment of tax changes rarely had much predictive power about where stocks headed thereafter. Counterintuitively, average and median returns in the 6 and 12 months after income-tax rate hikes far exceeded those following cuts!i But, more importantly: Stocks’ direction usually wasn’t much affected by rate changes, for good or ill, hike or cut. And, even when it may appear to have affected things, reality usually isn’t so clean.
Why don’t these changes impact stocks much? In all likelihood, it’s because tax policy is arguably the most widely watched area of politics. When a rate change is coming, the debate is usually heated and long-lasting. Since this directly hits most voters’ wallets, the public is also very attuned to developments. This debate and scrutiny allow markets to gradually adjust to whatever reality will be after the hike or cut is law. Moreover, markets are fully global and often removed from US tax law. After all, foreign investors, US retirement plans and many institutions generally aren’t affected by these rules.
In about a month and a half, we’ll know who the next US president will be, and you should expect him or her to talk up tax proposals. Such policies are undoubtedly important generally and quite possibly to your personal finances. But for stocks, don’t overrate their importance. Stocks just aren’t fixated on tax policy.
Please note: Tax law is complex. While we believe the tables above are an accurate representation of rate history, these tables may not reflect various factors (such as excess-profit taxes, phase-ins, rates on special categories of gain and AMT) that could have affected taxes throughout the years.
i This is still true if you exclude the years before 1946, which have big return outliers in some cases.