Influence of Tax and Tariff Policies on Equity Markets
Tax and tariff policies significantly influence the stock market by affecting corporate earnings, investment strategies, and overall market sentiment. As we approach the 2024 U.S. presidential election, analysts are closely examining the potential impacts of proposed policies from leading candidates Donald Trump and Kamala Harris.
Trump’s Tax and Tariff Strategy
Donald Trump's platform emphasizes using tariffs as a tool to generate revenue, intended to offset the extension of the Tax Cuts and Jobs Act (TCJA). However, analysts believe that the current tariff proposals, if enacted, may not sufficiently balance the incremental funding gap caused by extending the TCJA. While de-regulatory and lower tax proposals are generally more favorable to equity markets, higher tariffs, despite potentially generating revenue, are unlikely to cover the cost of the extended tax cuts. These cuts are projected to create a $4.6 trillion deficit over the next decade. Thus, while Trump's policies might initially appear market-friendly, they may face challenges in fully supporting equity markets without additional fiscal adjustments.
Harris’s Approach to Corporate Taxation
Kamala Harris’s platform suggests continuing and expanding existing policies, focusing on increased corporate taxes to fund additional spending programs. Harris’s previous policy stances indicate a significant risk to U.S. equity fundamentals, especially if corporate tax rates rise from 21% to 35%. Such an increase would directly impact corporate earnings by reducing the free cash flow available for investments and shareholder returns. In a hypothetical scenario where corporate tax rates are raised, the effective tax rate for companies could increase substantially, leading to additional tax payments and reducing expected Earnings Per Share (EPS) growth from 15% to 4% for 2026.
Role of Congress and Market Implications
Both candidates' policies underscore the importance of Congress in shaping the final impact on equity markets. A unified Congress, irrespective of whether it is under Republican or Democratic control, could facilitate the enactment of comprehensive tax and tariff policies. Conversely, a split Congress might lead to gridlock, complicating the implementation of significant policy changes.
Domestic vs. International Income Split
When assessing the implications of higher tax rates, it's crucial to consider the domestic versus international split in pretax income. Companies with a higher percentage of pretax income in the U.S. are more vulnerable to changes in U.S. tax policy. For example, small and mid-cap companies (SMID) often face higher tax rates compared to large-cap companies, making them more susceptible to adverse effects from increased corporate taxes.
Uncertainty in Revenue from Tariffs
While tariffs are a key revenue-raising initiative in Trump's policy platform, they may not be sufficient to replace income taxes entirely. The relationship between higher tariff rates and reduced import volumes suggests that increased tariffs could dampen import activity, limiting potential revenue gain. This interaction between tariffs and trade volumes introduces additional uncertainty into the market as global supply chains adjust to new tariff structures.
