In the last couple weeks, things have been getting much more specific about President Biden’s plans to increase corporate taxes, and his plans have got a lot of media air time. Further, signs are suggesting the tax hikes will be legislatively possible to do pass. For example, on Monday, the Senate Parliamentarian concluded that reconciliation can be used more than once this year, meaning that if a majority in the House and Senate can agree on a tax bill, it can become law. The proposed hikes are not minor tax adjustments. The corporate rate increase would be meaningful, the tax on foreign income would be substantial, and, the tax on book income would lay the hurt down on some of the biggest corporations on earth. But yet, as one of my accounting colleagues here at UNC recently noted, we have not seen a large drop in the stock market that seems attributable to taxes. What gives?
I have not pulled market data and looked (maybe we did see a drop I didn’t notice!), but, in my mind, here are some possibilities:
1. The stock market was clever enough to know that Biden was the likely winner of the election, and, the tax effect of all his campaign promises got priced in slowly over time. This is to say that the events in the last few weeks with these big announcements are in the national media, but, to the market, are not “news”. But, one might respond, the market has done nothing but rise since it was likely Biden would win. But, remember, the market does not just go up and down—maybe it would have risen even more without the promises of the tax hikes.
2. The market still does not actually think the tax hikes will happen. Joe Manchin will come to the rescue, the world will end, or something. And, it could be that the market is right–this may well not pass, and it only look likely to us because we are just reading what the media has to say about it–the market, with access to the inside information, knows better.
3. The market may think firms will be able to plan around these tax increases, and still not pay much more in tax. For example, if Biden is able to get passed a law that taxes book income, firms could simple report lower GAAP income, and, then signal to the market their pre-tax-planning book income with a pro-forma number. Or, as happened many times when Biden was the Vice President but not since the tax reform of 2017, firms will expatriate, renounce their US citizenship, and avoid the tax burden President Biden is planning on imposing.
4. It could be that while these corporate taxes will be extracted from public firms, much of the benefits of the bills these taxes are purportedly funding will also go back to those same firms. Someone will be taking care of old people (the biggest part of the current version of the infrastructure bill). Someone will be selling electric vehicles and installing charging stations, etc. It may well be public firms profiting from all that spending. So, the net effect may not be all that large.
5. The market thinks that Biden will get his tax plan, but, will the GOP will prevail in the House and Senate in 2022 or 2024, and, holding the reins, will somehow reverse the tax policy. Or something. This is to say, the law will become law, but, will be short-lived.
6. It could be that the market believes that in an economy with high unemployment, this time around, labor will bear the burden of the tax increase. That is to say that while corporations will send larger checks to the IRS, they will simply turn around and pay employees less, and, given the state of the economy, employees will just have to lay down and accept the lower pay.
7. It could be that the market believes that in an economy where some goods are still hard to find, shortages are more common than before, etc., consumers will bear the burden of the corporate tax increase. That is to say that while corporations will send larger checks to the IRS, they will simply turn around and charge consumers more, and, given the state of the economy, consumers will just have to pay it.
I don’t know of any way to currently disentangle all these stories (and the others I omitted). But, all of them (except maybe #1) are pretty interesting to me. If the tax hike ultimately happens, we will be able to dismiss #2 (because we will see a downward plunge at some point). The others are a bit trickier, especially since, given the precedent we are setting, republicans will just turn around and reverse all of this just to spite democrats the next time they hold the reins, and some of these stories will take a long time to work their way out. We shall see.
**update** 1/12/2022 – We cannot know, of course, what the market knew back then. But, it looks very unlikely now that the corporate tax rate will inrease (although it was Senator Sinema, not Manchin, who allegedly brought this about).
