According to History, Not Much
Over the past few months, much has been made of tax reform–corporate tax reform in particular–and its implications for markets. The talking heads on CNBC bat around “what if” scenarios like callers on sports radio approaching a trade deadline. As we inch toward approval, consensus opinion has it that lower taxes lead to higher earnings, which will produce higher stock prices. But there is some variability in potential outcomes. If tax reform is approved and the corporate tax rate is lowered, forecasters’ predictions about the outcome range from no effect to materially positive (mid to high single digits in most cases we’ve seen). If not approved, forecasters’ predictions range from no effect on markets to a potential crash1, according to Treasury Secretary Steven Mnuchin.
The problem with all these predictions, beyond not having any way to verify how accurate these forecasters have historically been, is that they cannot be measured for success. They are simply an exploration of various outcomes that could happen in the short term. But does this really matter in the context of a long time horizon?
To answer that question, we set out to examine the history of the top corporate tax rate since 1936 and its effects on public equity returns. As seen below, the tax rate for corporations rose from 15% in 1936 to 52.8% in 1969. From that point, the top tax rate for companies has fallen to 35%, with some plateaus along the way. In the first period, 1936-1969, the average annualized return for the S&P 500 index was 10.6%. From 1970 to 2016, a period of falling corporate tax rates, the average annualized return for the S&P 500 was 10.3%, lower than the rising corporate tax regime.
Historical averages indicate that the direction of corporate tax rates (increasing vs. decreasing) makes little, if any, difference to long-term average returns. But what about the level of taxes? Would that tell a different story? The average tax rate2 over our sample period is 40.8%. Using that to cut the data set into “high tax years” vs. “low tax years”, we then calculated the average calendar year return in those periods. Interestingly, the results were again counterintuitive as seen below.
Source: taxpolicycenter.org, FactSet, Lake Street Advisors
Our conclusion, in the context of managing a diversified portfolio designed to achieve the long-term objectives of clients, is that the direction and level of corporate tax rates does not matter to the returns generated from U.S. public equities. While the media hypes up these seemingly important and uncertain events with opinions from a swath of experts, a more informative exercise might be asking why this potential reduction in corporate tax rates would be different from what has happened in the history of corporate taxes.
2Simple average of top corporate tax rate by calendar year