Tax hikes are coming

Tax hikes are coming

Nancy Cook at Bloomberg writes today that Biden officials are more determined that ever to raise taxes on the wealthy after the pandemic.

They're convinced of the need to raise money and put off by the large market-driven gains for the wealthy and K-shaped recovery. They think the political winds are blowing in their favor, especially at the $400,000 cutoff that Biden set during the election.

Higher income taxes on higher earners won't be a problem for the market, particularly if that money is redistributed to child card and infrastructure, two of Biden's priorities. If anything, that's a net positive.

The issue is on capital gains or corporate taxes. If you believe that a rise in capital gains rates is coming in 2022, what do you do before year-end in 2021? You sell, of course. That's not a factor at the moment but it will be later in the year, especially with the report saying capital gains could be taxed as income for the largest gainers (37% rate vs 20% or less currently). That's a big incentive to sell.

Corporate taxes are another avenue that Democrats will explore and a 1-2 pp hike isn't particularly problematic but beyond that, it starts to be a challenge. There's also a discount that slowly gets built into the market around the uncertainty of it.

So while there's an intense focus on monetary tightening right now, the avenue that hits markets first could be on the fiscal side.

At the same time, if the Fed and Treasury work hand-in-hand, that fiscal tightening could prolong the period of low rates, softening the economic blow. I have no doubt that's what Yellen and Powell plan but the timing and execution of it is the hard part.

How to trade it? For now the focus is entirely on the reopening but starting around September, the fiscal reckoning will weigh.