I’ve been on my soapbox lately demonstrating that history suggests that elections do not mean nearly as much for equity markets as many investors suspect. Case in point, the average annual return on the US equity market, as represented by the S&P 500 Index, has been 10.1% since 1957.1 Per the rule of 72, that’s a doubling of one’s investments roughly every 7.1 years across the terms of 12 different US presidents. For more potential fodder to ease election concerns, please refer to “2020 US Presidential Election: 10 Truths No Matter Who Wins.”
The first question I inevitably receive as I conclude my presentation and come down from my platform (and by that I mean the same chair I have been sitting in for the past seven months) is, “But what if the capital gains tax is increased?” Joe Biden has proposed increasing the top tax rate for capital gains for the highest earners to 39.6% from 23.8%.2 Inherent in that question is a concern that investors will dump their equity positions prior to the end of the year to lock in the lower capital gains rate, thereby driving markets meaningfully lower.
I make the following five points to respond to that ever-present question:
1. Yes, it is true that the two previous hikes in capital gains taxes (the Tax Reform of 1986 and the American Taxpayer Relief Act of 2012) led to an increase in stock selling. For example, the total capital gains realized in 1986 climbed by over 7% of US gross domestic product, up from 3.9% the prior year.3 The increase in total capital gains realized in 2012 was not as drastic but noticeable, nonetheless.
Figure 1: Total capital gains realized vs. maximum tax rate on long-term gains
2. However, Biden’s tax proposal would apply only to Americans earning more than $1 million, assuming he wins the presidency and the Democrats have control of the House of Representatives and the Senate. For reference, the top 1% of income earners starts below $500,000 a year.4 Given that, the number of Americans affected and thus potentially inclined to sell equities would likely be significantly lower than the investors affected in 1986 and 2012.
3. While it is not anywhere close to a foregone conclusion that the Democrats will win the White House and control of the US Congress, it is also not a foregone conclusion how they would make use of that political mandate. We are hard pressed to imagine that a Biden administration would focus a potentially fleeting political mandate to raise taxes during a weak and challenged economic recovery. Remember, the Obama administration extended the Bush-era tax cuts multiple times during the nascent economic recovery from 2009-2012.
4. In addition, US household share of US equity ownership has declined from nearly 60% in the early 1980s to 37% today.5 A large percentage of the stock market is owned by institutions, including pension funds, retirement accounts, and foreign investors that would not be subject to a capital gains tax.
Figure 2: Share of US corporate equity market
5. US equity markets, as represented by the S&P 500 Index, performed well in the 15 months that included the year before the signings of both the Tax Reform Act of 1986 and the American Taxpayer Relief Act of 2012 through the three months after the signing. In fact, the cumulative daily returns over those periods were 45% and 22%, respectively.6
Figure 3: S&P 500 cumulative daily price return
1-year before to three months after a capital gains tax increase
The Beatles’ George Harrison sang, “Be thankful I don’t take it all.” I, for one, am thankful that a potential capital gains tax increase is unlikely to have as big of an impact on the markets as many seem to suspect.
1 Source: Bloomberg, L.P., as of 6/30/2020
2 Source: Tax Foundation
3 Source: US Department of Taxation, US Bureau of Economic Analysis, as of 12/31/2014. The study was conducted through the end of 2014 and has not been updated by the US Department of Taxation.
4 Source: US Census Bureau, as of 12/31/2019.
5 Source: US Federal Reserve, as of 4/30/2020.
6 Source: Bloomberg, L.P., Invesco
Image Credit: Maskot/ Getty
The S&P 500 Index is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
The opinions referenced above are those of the author as of September 30, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions.
All data provided by Invesco unless otherwise noted.