By: Wayne Duggan
Investors won big during the 2nd-quarter earnings season, and the economic rebound has the S&P 500 well-positioned to continue to deliver impressive earnings growth in coming quarters.
However, tax policy is a major wildcard for earnings growth in 2022, and experts say corporate tax hikes could potentially eliminate all earnings growth next year.
Biden’s Tax Plan
U.S. President Joe Biden has proposed tax policy changes to help pay for his American Jobs Plan infrastructure bill. Biden is proposing slight changes to individual income taxes, but the biggest potential risk to S&P 500 earnings is his proposed corporate tax changes.
Biden has proposed increasing the U.S. corporate tax rate from 21% to 28%. For perspective, the U.S. corporate tax rate was 35% back in 2017 prior to former President Donald Trump’s tax cuts.
Biden also is proposing a 15% minimum tax on corporate book income. A company’s taxable income is often lower than its book income, the income it reports publicly to shareholders. Congress dictates the rules by which a company calculates its taxable income to report to the IRS. Income reported to investors is determined by Generally Accepted Accounting Principles (GAAP), a set of rules created by the Financial Accounting Standards Board (FASB).
Finally, Biden plans to tax capital gains and dividends as ordinary income for taxpayers who have taxable income of at least $1 million. Biden also plans to tax capital gains at death for unrealized gains above $1 million for individuals and $2 million for joint filers.
What Does it Mean?
Given Biden is a Democrat and both houses of Congress are controlled by Democrats, analysts and experts believe there is a good chance there will be at least some changes to corporate tax policies before 2022.
LPL Financial (NASDAQ: LPLA) estimates there is about a 70% chance of a tax hike. LPL is currently projecting 2022 S&P 500 earnings per share (EPS) of $218. However, the firm said EPS could be $225 if corporate taxes are not raised. In other words, LPL estimates Biden’s tax proposal could reduce S&P 500 earnings by about 3.1%.
Bank of America Corp. (NYSE: BAC) is targeting $215 in EPS for the S&P 500 in 2022, only about 5% annual growth compared to 2021. But Bank of America has said that earnings growth could drop to 0% in 2022 if Biden’s full corporate tax plan is implemented as is.
Politics and Trading
Politics has become one of the most divisive and controversial topics of debate in America these days. But the best traders don’t let political ideology influence their rational trading strategies.
Whether you are a Democrat, a Republican or neither, corporate tax hikes are likely coming sooner rather than later. Those tax hikes could take a bite out of corporate earnings in 2022, and traders should be prepared for the potential market fallout.
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