What Investors Need To Know About Corporate Taxes In 2022
Summary
- The issue of corporate taxes was the single biggest concern for Wall Street.
- The initial 28% corporate tax rate proposal had already been scaled back to 25%. And even 23% was bandied about for several weeks.
- Wall Street has very little to fear from the bill as it’s currently constructed.
- This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Learn More »
DNY59/iStock via Getty Images
This article was co-authored by Dividend Sensei.
I do think it’s usually best to get another perspective. That’s why I have people like Dividend Sensei on my team… and why I welcome his input into the ongoing political battles.
That’s not to say this article is meant to get political. It’s not about politics per se. But politics do have economic and financial repercussions, so we do need to discuss what’s going on in Congress right now.
Ultimately, you can agree or disagree with Dividend Sensei’s conclusions. But I hope you take the time to read what he has to say to regardless.
And, as always, feel free to leave your comments down below.
So without further ado, here’s his take on the matter and what to expect…
Dividend Sensei Discusses the Tax Situation
This has been a very dramatic year in Washington, D.C. There was the $1.9 trillion stimulus bill passed in March. And now we’re seeing a protracted battle over two major infrastructure bills.
Whenever there’s government spending, investors start worrying about higher taxes. And that’s especially understandable right now considering current stock market projections.
JPMorgan (JPM) estimates that the S&P 500 is now 27% historically overvalued. As such, it’s offering very tepid returns for the next five years.
Adjusted for inflation, the index’s risk-expected returns are near zero for the next five years.
So if corporate tax rates went up to 28% in 2022, as was originally proposed, Goldman Sachs estimated that corporate profits could have faced a 13% headwind.
Instead of +8% growth, it could have been -5%.
Given the euphoria in much of the market, that was almost certainly not priced in. Therefore the chances of a 10%-20% correction would have increased significantly.
But thanks to centrist Democratic Senator Kyrstin Sinema of Arizona, the focus has shifted from corporate taxes to taxes on the richest 700 Americans in recent weeks.
Then there was a proposal for taxing unrealized capital gains at 23.8%. This could have required founders like Elon Musk and Jeff Bezos to sell 23.8% of their stock within five years – and potentially a lot more if their companies keep growing at such rapid rates.
Yet that’s now pretty much gone too.
While the final negotiations for the reconciliation bill are still ongoing, Democrats could end up voting on it any day. So here's what investors need to know.
A Much Smaller Bill – Just as Analysts Were Expecting
Initially, Senator Bernie Sanders proposed a $6 trillion plan. Political experts considered it a widely optimistic opening bid designed to smooth the way for a relatively smaller – but still ambitious – $3.5 trillion proposal.
But even that $3.5 trillion plan ran into the brick walls of Senators Joe Manchin and Sinema. They refused to even consider such a large package. And with a 50-seat majority, even a single defection would have killed the reconciliation bill.
At the same time, progressives in the House haven’t allowed a vote on the bipartisan $1.2 trillion bill. So a defeat of the reconciliation plan could have spelled the death of the total infrastructure investment effort.
So what’s in the current round being negotiated? According to the BBC, that would be:
- $555 billion to fight climate change, mainly through tax incentives for alternative energy manufacturers
- $400 billion for free and universal preschool for 3-4 year-olds
- $150 billion to build one million affordable housing units.
Last week, President Biden declared that a framework for a final, successful, passable reconciliation bill did exist. That’s because most of the most contentious proposals had been removed, including Medicare negotiating bulk drug price discounts…
Though some Democrats are still trying to get a watered-down version of that proposal back into the final package.
As already noted, the initial tax proposals have also been noticeably whittled down. To cite BBC again:
“The plan promises to offset its $1.75 [trillion] cost with an estimated $2 [trillion] in revenue increases, according to the White House, a 15% minimum tax on the reported profits of large firms, an additional 5% tax on incomes of more than $10m annually and another 3% tax on incomes above $25m, [and] increased enforcement to cut down on tax evasion by large corporations and the wealthy."
The issue of corporate taxes was naturally the single biggest concern for Wall Street. But the initial 28% corporate tax rate proposal had already been scaled back to 25%.
(For context, the current corporate tax rate is 21%. Though each individual industry and company can have very different tax rates in the end based on various deductions.)
The current proposal, which is likely to pass, would set a 15% minimum corporate tax rate – coinciding with the new global 15% minimum corporate rate that Secretary Yellen has negotiated with over 130 countries.
Barron's estimates that a 15% minimum corporate rate would reduce 2022 S&P 500 earnings by $1. And since FactSet's bottom-up consensus is $218.72 next year, a 15% rate could reduce corporate earnings by 0.5%.
But keep in mind that, before this new framework was agreed to… Goldman (GS) and BlackRock (BLK) were estimating a 25% corporate rate that could reduce next year's earnings by 7% to +1%.
Both were expecting such a corporate rate increase to trigger a completely healthy and normal market pullback. And JPMorgan was estimating about an 8% peak decline.
How would a 0.5% decrease affect the market? Potentially not at all, and here's why.
The weighted consensus 2021 tax rate for the 25 largest companies in America – which make up 41% of the S&P – is 16.42%. With the rare exception of companies like PayPal (PYPL), NVIDIA (NVDA), Tesla (TSLA), and Bank of America (BAC)…
All of the U.S.’ biggest companies already pay 15% or more.
The proposal to tax buybacks could have a larger impact, though that’s for just a 1% surcharge on buybacks. In other words, Wall Street has very little to fear from the bill as its currently constructed.
And the benefits could well outweigh any higher taxes (of perhaps just 0.4%).
This New $1.75 Trillion Bill Could More Than Offset Its Corporate Tax Increase
Moody's economists had previously calculated the potential economic impact of the full $4 trillion infrastructure bills. Their base-case forecast was 1% faster economic growth over 10 years.
And Bank of America was highly optimistic about what this could mean for faster corporate profit growth. Forbes wrote:
“All told, the bank estimates... that each 1% move in U.S. GDP growth should translate into roughly 3%-4% growth in the earnings of S&P 500 companies."
In other words, the full $4 trillion infrastructure bill could have boosted S&P earnings growth by 3%-4% from 8.5% to 11.5%-12.5%, according to FactSet.
This far smaller bill would mean a $2.3 trillion combined infrastructure bill, representing about 1% of GDP over the next decade.
In other words, the likely benefit to growth will be smaller. Moody's has yet to fully analyze the new bill, so we don’t know by how much. Most likely, it’s waiting until everything is said and done before running its complex economic model again.
The best we can do for now is to assume that a $2.3 trillion package would be 57% as effective at boosting growth as a $4 trillion package. That translates into the potential for:
- 0.6% faster economic growth over a decade
- 1.8%-2.4% faster earnings growth
- 10.3%-10.9% CAGR growth instead of 8%.
Now, it's important to remember that, historically, the FactSet consensus tends to overestimate earnings growth. Moreover, Deutsche Bank (DB) isn’t convinced that corporate America's profit growth will be much changed from its 85-year average of 6.5%.
The reason for potential investor optimism is the simple fact that the five tech giants are now such a large part of the market – and still growing much faster – that the weighted growth rate of corporate profits could indeed rise to 8.5%.
That's especially true if there’s a minimal impact on their corporate tax rates.
In Conclusion…
While, at last check, Democrats were cautiously optimistic that they’re in the endgame of these large infrastructure bills, there is always a chance that the negotiations might end up dragging out several weeks longer.
However, the consensus among economists and analysts is that the two bills will pass. And, for now, it appears that the combined package will be $2.3 trillion in new spending over 10 years.
Besides, the $2 trillion in higher taxes are unlikely to actually happen. Accountants for companies and the rich are very good at finding loopholes, after all.
So, as things stand now, it appears that corporate profits will only increase by about 0.4%. And that would mostly come from a 1% surcharge on buybacks…
which might end up cut from the final deal anyway.
Basically, it appears that whatever modest boost to the economy this infrastructure spending will deliver is likely to be far larger than any modest headwind to corporate taxes.
And if the final reconciliation bill solves the debt ceiling crisis – at least for another year – it's very possible that Wall Street might celebrate this large infrastructure spending with its historical Santa Claus rally.
Since 1950, the average Santa rally is 4%-5%. And many analysts believe the final two months of 2021 could indeed result in a very merry Christmas for investors.
Author's Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.
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This article was written by
Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 175,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) iREIT on Alpha (Seeking Alpha), and (2) The Dividend Kings (Seeking Alpha), and (3) Wide Moat Research. He is also the editor of The Forbes Real Estate Investor.
Thomas has also been featured in Barron's, Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox.
He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, 2022 and 2023 (based on page views) and has over 111,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley) and is writing a new book, REITs For Dummies (Wiley/Amazon).
Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College, and he is married with 5 wonderful kids. He has over 30 years of real estate investing experience and is one of the most prolific writers on Seeking Alpha. To learn more about Brad visit HERE.Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (31)
Thanks. Seems I have gotton far afield from tax reality, and your quite clear article dispelled several misconceptions.
How many profitable corporations pay ZERO taxes? How are we going to pay for an infrastructure upgrade? Nothing happened the last 4 years and apparently nothing is going to happen is the next 4.
... should be lowering spending...
Well now, defense budget higher than the next 10 highest nations combined!
