Nearly six months into President Joe Biden’s administration, Wall Street remains divided over the likelihood, and impact of, one of the Democrat’s key campaign promises: Higher taxes.
While the president and his cabinet have made progress in persuading foreign partners to back a global minimum corporate tax rate, the Biden team does not appear any closer to passing the types of sweeping tax reform he promised during his 2020 campaign.
Among the many components of the Biden tax plan are an increase in the domestic corporate tax rate to 28% from 21% and the top individual income tax rate to 39.6% from 37%. The White House also wants to raise the capital gains tax rate on those making over $1 million a year from its current 20% to 39.6%.
But with the GOP resolute against tax increases, and with a handful of economists concerned that raising taxes now could risk the economic recovery, some say the outlook for the administration’s tax plans has grown murkier in recent months.
The chances of big tax reform in the near term seem reduced, said Tony Fratto, who served as Treasury official in the George W. Bush administration.
“I don’t want to say that the fight is over on that quite yet, because I know that there are still proponents of that. But I think that they are hard fights,” he said Tuesday morning. “On the corporate side, coming out of the economic situation we’ve been in, you can make a case that you don’t want to squelch the return to growth and job creation, when there are still many millions of people out of work relative to pre-Covid.”
Though the economic recovery over the last year has yet to see the labor force return to its former size, the employment situation was even worse when then-candidate Biden touted his ambitious tax reforms on CNBC in May 2020.
Higher taxes on capital gains and on the wealthy would not only help bankroll government stimulus, Biden said at the time, but also address the growing wealth gap in the U.S. by forcing the rich to pay what he considered their fair share.
“My tax policy is based on a simple proposition, which is to stop rewarding wealth and start rewarding work a little bit,” Biden said on May 22, 2020. “Taxes are going to build back a better economy, boost it, create a middle class, and create jobs, Paycheck Protection Program, health care, the confidence to come back.”
BlackRock: Modest tax hike likely
To be fair, the lack of headway on tax reform is not necessarily for lack of effort by the Biden administration.
Any mention of raising the domestic corporate tax rate from its current 21% is a non-starter for Republicans and some economists, who say it’s still too early into the economic recovery to ask the nation’s businesses to send an even greater proportion of their profits to Uncle Sam.
That opposition poses a significant barrier for Democrats, who hold a narrow majority in the House and are split 50-50 with the GOP in the Senate.
Despite a $1.9 trillion Covid-19 rescue law, a $1.2 trillion physical infrastructure plan and another $1.8 trillion proposed for families, child care and paid worker leave programs, the Biden administration has failed thus far to bring its tax proposals as far.
Tax increases are “off the table,” Sen. Mitt Romney, a Utah Republican involved in the bipartisan infrastructure talks, told reporters last month. Sen. Jon Tester, a Montana Democrat who has joined in the negotiations, said at the time that paying for infrastructure “is probably the toughest part about this, from my perspective.”
BlackRock, the world’s largest asset manager, told clients in late June that it still expects the Biden White House to raise some taxes to help offset the historic level of spending.
“The direction of travel for corporate taxes, even though the outlook is uncertain, is higher,” Kurt Reiman, BlackRock’s senior strategist for North America, told CNBC last week. “We think the Democrats are going to use this open window during the summer and fall, ahead of campaigning for the midterms, to advance their legislative agenda.”
Specifically, BlackRock’s managers warned that if the proposed 28% corporate income tax rate and a 21% global minimum tax were imposed, the earnings per share of the S&P 500 could fall as much as 7% lower in 2022.
Reiman and his colleagues believe that while it’s likely Democrats will manage to move tax rates higher, the hikes will be more modest than Biden’s initial proposals. They note, for example, Biden’s willingness to consider a more moderate increase in the top corporate tax rate to 25%, as favored by key centrist Sen. Joe Manchin, D-W.Va.
“These programs are going to need to be financed in part by higher corporate — and maybe even individual — tax rates if they’re going to pass it through the Senate under reconciliation,” Reiman added.
JP Morgan: Biden can’t deliver
Others take a more pessimistic view about Biden’s ability to muster enough support for higher levies.
“We do not believe that US politics will hurt US stocks in absolute terms, as it is unlikely that Biden will be able to deliver on some potentially market-unfriendly proposals on taxation / Tech regulation,” JPMorgan’s equity strategy team told clients on Monday.
“In relative terms though, investor sentiment might be impeded as there is a headline newsflow risk with respect to some of these policies,” they added.
To Bush-era Treasury official Fratto, the strained negotiations between Republicans and Democrats over how to pay for infrastructure are almost nonsensical given how cheap it is to borrow.
“Borrowing has been cheap for a long time. It is exceedingly cheap now, and it’s not clear that that is going to change,” he said. “When you don’t have that pressure of the ever-increasing cost of your debt, the pay-for arguments get to be really hard.”
Between the Federal Reserve’s easy monetary policies and robust demand for U.S. debt around the world, interest rates on American bonds have fallen for much of the past decade. The rate on the 10-year Treasury note, which traded north of 6% in 2000, was last seen around 1.3% after wallowing under 1% for much of 2020.
But Fratto isn’t the only one who sees untapped potential in the market for sovereign debt.
Citigroup strategist Vikram Rai has for months touted the appeal of an Obama-era tool known as Build America Bonds. These special, taxable municipal bonds allow states and counties to issue debt with interest costs subsidized by the federal government.
The Obama administration first introduced the bonds (known as BABs) in 2009 to finance capital projects and jumpstart a struggling U.S. economy as it climbed out of the Great Recession.
“The arguments on paper through my whole career in Washington, going back to the late 1980s and early 1990s, was this story that was told that we need to pay for [stimulus]. Otherwise, bond rates are going to spike or we’re going to get inflation,” Fratto said.
“Whatever the limit is that would result in saturating the market with Treasurys, we haven’t discovered it,” he continued. “And we seem to be far away from it.”
