Tax Increases Are Not Always A Headwind For Stocks

Earlier this week, the equity market reacted negatively to the Biden Administration's tax proposal, specifically an increase in the capital gains tax rate. In the proposal, which he plans to discuss in a speech before a joint session of Congress next week, the capital gain tax rate on households making more than $1 million is intended to increase to as much as 43.4%.

This is arrived at by increasing the capital gain tax rate to 39.6%, with the extra 3.8% Medicare tax for incomes above $200,000 for single filers and $250,000 for joint filers. The current top capital gain tax rate is 20%. When news of the tax increase came out on Thursday, the Dow Jones Industrial Average ended up declining over 300 points on the day.

Dow Jones Index on April 22, 2021

The market's initial negative reaction centered around concerns that increased selling would take place this year along with potential headwinds due to higher taxes. Certainly this large of an increase in the capital gain tax rate seems unproductive, and one would think bipartisan negotiations would result in a smaller increase.

However, investors should be mindful of the fact that a smaller percentage of stock holdings are held in taxable accounts. The Tax Policy Center prepared the chart below in a report late last year. The grey chart area represents the percentage of stocks that are held in taxable accounts.

In the mid-1960's, as much as 80% of stock holdings were in taxable accounts. As of 2019, the weighting has declined to just 25%. The significance is a lower amount of stocks will be subject to the higher capital gain tax rate anyway.

Ownership Percentage of U.S. Stocks

And lastly, with the high likelihood of higher tax rates being in place in 2022 and beyond, investors should note this has not always been a headwind for stocks. The chart below from BMO Investment Strategy Group shows the performance of the S&P 500 Index during periods wherein taxes were either raised or lowered since 1945.

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Disclaimer: The information and content should not be construed as a recommendation to invest or trade in any type of security. Neither the information nor any opinion expressed constitutes a ...

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