The Biden administration’s tax proposal seeks to increase the corporate tax rate from 21% to 28%, repealing about half of the decrease from the 2017 Tax Cuts and Jobs Act. Consensus believes that the hikes will be meaningfully smaller (around 25%) than those proposed, due to Democrats’ slim majority in Congress and moderate Democrats who do not want excessive tax increases. As a result, the increase in tax revenue likely will not be enough to pay for the costly infrastructure plan plus the other stimulus that is expected to come; thus, the deficit will likely increase even further. This brings some investors to worry that increasing the deficit after the extreme spending measures brought upon by the pandemic can likely lead to greater inflation.
Fiscal stimulus and easy monetary policy already have us in the easiest financial conditions on record; increasing the deficit further possibly could cause the Federal Reserve to act sooner than expected to slow down the economy from overheating, leading to a shortened growth cycle. This could then lead to increased steepening of the yield curve and market leadership repositioning. When the tax cuts took effect during the previous administration, the greatest beneficiaries in the United States were small-cap stocks. Because of this, we suspect that small caps likely will take the biggest hit if the corporate tax rate does increase, but it’s only one factor to consider when making investment decisions.
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