The Obama administration is reportedly holding off on closing a tax "loophole" affecting US multinational companies.
In the face of the downturn and rising government spending, talk of other tax increases is in the air.
Regardless of whether this corporate tax provision is eliminated or other tax hikes pass, the effect on the stock market will likely be more muted than anticipated.
Reports circled today the White House is stepping back from a campaign pledge to close a reported $200 billion tax "loophole" allowing US multinationals to defer taxes on profits made abroad until they're repatriated in the US. As you might imagine (especially amid an economic downturn), companies lobbied extensively against the change.
While critics see this deferral as an incentive for US firms to expand operations abroad, US businesses contend the provision enables them to compete globally—unlike the US, most industrialized nations only levy taxes on companies' domestic profits. This, in turn, boosts business' bottom lines and naturally also supports US operations.
However, it isn't just corporate taxes on investors' minds. Rising government spending has increased fears of other tax increases. But there are important factors working against near-term tax hikes—politics for instance. Mid-term elections are around the corner, and moderation is key for campaigning incumbents. The government's already grappling with negative public perception surrounding elevated unemployment and trying to sustain economic recovery. Proposing higher taxes in this environment won't be too popular with valuable independent voters.
Not to mention, raising taxes doesn't typically produce the intended results. Higher tax receipts? On the contrary—increased taxes can create a disincentive to produce and earn, actually reducing tax revenue. Raising taxes can also drive individual earners and businesses away. Businesses, and their investment and human capital alike, are mobile. This is evidenced by the exodus from high-tax states in the US but applies globally.
Between 1998 and 2007, no-income tax states created 89% more jobs and personal income grew at a rate 32% faster than in high-tax states. Over this same period, upwards of 1,000 people relocated every day from the nine highest income-tax states to predominantly the nine states with no income tax. Similarly, firms are free to seek more tax-friendly countries to host their operations.
Tax hikes can be a direct hit to businesses' and wage earners' bottom lines, but the effects for stock investors aren't so immediate. Regardless of whether this corporate tax provision is eliminated or other tax hikes pass, the effect on the stock market will likely be more muted than anticipated. Historically, changes in the income tax, corporate tax, or even capital gains tax rates aren't a boon or bust for stocks. For example, in 1981, stocks moved lower even after capital gains taxes were cut, and stocks rose following a subsequent rate increase in 1986.
While higher taxes are demonstrably detrimental to a friendly business climate, their relationship to the stock market is much less direct. The factors influencing stocks are myriad—tax rate changes are just one small piece of the puzzle.