October 30, 2020

How will Biden’s 28% Corporate Tax Plan Affect S&P 500 Earnings?

by David Aurelio.

One of the Trump administration’s major accomplishments was corporate tax reform. U.S. presidential candidate Joe Biden proposes raising the corporate tax rate by 7 percentage points to 28%. If former Vice President Biden is elected and his corporate tax plan is enacted, the S&P 500’s current earnings estimates could see a roughly negative 10.6% impact.

Exhibit 1: S&P 500 Y/Y CapEx vs. Effective Tax Rate

Source: I/B/E/S data from Refinitiv

Note: Based on current constituents and weights

The Tax Cuts and Jobs Act of 2017 (TCJA) cut the U.S. corporate tax rate from 35% to 21%. One of the goals of this tax cut was to disincentivize companies from performing tax inversion, where they purchase a smaller foreign corporation and adopt the takeover target’s headquarters to obtain a lower tax status.

Exhibit 1 above shows that while the corporate tax rate was 35%, in the years leading up to the TCJA, the aggregate effective tax rate for the S&P 500 was roughly 27%. This suggests that a 28% corporate tax rate may result in another round of corporate inversions.

Another goal was to incentivize corporations to invest the earnings from savings due to lower taxes into growth opportunities. One metric suggests that this second goal was achieved as a sharp pickup in year-on-year (Y/Y) capital expenditures (CapEx) can be seen staring in 2017. However, COVID-19 has caused companies to drastically cut back on capex and analysts now expect a 10% decline in 2020 from the prior year.

Implementation of the TCJA had a direct impact on S&P 500 earnings, which can be seen in the jump in 2018’s 23.0% Y/Y aggregated EPS compared to the 13.3% growth obtained by assuming an effective tax rate of 27%.

However, it is worth noting that this doesn’t account for indirect impacts such as share repurchases, the impact that increased CapEx has on other businesses, etc. Therefore, it likely understates the full impact that the tax cut had on earnings.

Exhibit 2: S&P 500 28% Effective Tax’s Impact to 2021 EPS Estimates by Industry Group

Source: I/B/E/S data from Refinitiv

If Biden is elected and were to immediately implement a 28% corporate tax rate, then the S&P 500’s 2021 earnings would likely come in 10.7% below current estimates. The energy, real estate, and information technology sectors are expected to be the hardest hit, with 2021 earnings declining 44.3%, 18.9%, and 14.0% respectively. The materials (-3.0%), financials (-5.1%), and consumer discretionary (-6.6%) sectors are expected to experience the lowest impacts. Exhibit 2 above shows a more detailed look how the industry groups are expected to be affected.

Exhibit 3: S&P 500 Percentage Difference between 28% Effective Tax Implied EPS vs Current

Source: I/B/E/S data from Refinitiv

In reality, it is unlikely that an increase in corporate taxes would be implemented immediately. However, analysts’ long-term estimates tend to change meaningfully. Therefore, it makes sense to look at the direct impact a 28% effective tax rate would have had on the S&P 500’s historical earnings as well as the projected earnings.

By taking the average impact from 2018 through 2024, it is reasonable to assume that raising the corporate tax rate will decrease earnings by 10.6%. It is worth noting that while the effective tax rate is unlikely to come in at the full 28%, the indirect impacts of a higher tax rate aren’t being captured either.

Refinitiv Eikon is a complete solution for research and analytics. It places the most comprehensive market information, news, analytics and trading tools available into a desktop.

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