Election Year: The Circus is Here 🤡
What does history tell us about the market and corporate tax rates?
This is going to be a quick post to provide a bit of historical perspective on how changes in the corporate tax rate have influenced the S&P 500.
First, let’s be clear what drives the direction of the market over the long run. Earnings. When companies make more money the value of their shares appreciates. Check out Figure 1 below.
In Figure 1 the positive relationship between the S&P 500 Index and S&P 500 Earnings Per Share is obvious. As earnings per share increases, so does the value of the index.
Earnings Per Share = Net Income / Weighted Average Shares Outstanding
The standard belief is this:
Higher corporate tax rates will increase income tax expense and thus reduce net income. Holding the number of shares outstanding constant, this will reduce earnings per share. As earnings per share declines, so will the value of the S&P 500 Index.
Deutsche Bank recently released a fantastic, long term chart displaying the relationship between S&P 500 Earnings and corporate tax rates. Check out Figure 2.
Figure 2 seems to present contrary evidence to the popular opinion expressed above. The long-term trend growth in S&P 500 earnings has been remarkably stable throughout the 20th and 21st century regardless of fluctuations in the corporate tax rate handed down by politicians in D.C.
There are many reasons why tax rates have risen and fallen over time — but the one fact that has remained consistent is corporate America’s resilience and adaptability. Large American businesses, those that are members of the S&P 500, have been able to maintain stable long-term earnings growth regardless of the environment they’re presented with.
While I do believe competitive tax rates are extremely important for attracting capital and providing businesses and individuals with the proper incentives to take risk — it’s important to remember not to jump immediately into the bearish camp if tax rates do end up creeping higher.
— Brant
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