(Bloomberg Opinion) — If presidential contenders Kamala Harris and Donald Trump get their way, companies will be taxed at very different rates than they are now. Harris would raise the corporate tax rate to 28% from 21%. Trump would lower it to 15%.
The stock market doesn’t care about politics, as I often say, but it does care about profits, and tax rates directly affect the bottom line. That impact can be measured, or at least approximated, which is why the earnings assumptions underlying stock prices could change after the election. The question is how much, and what impact could it have on the broader stock market.
To find out, I looked at analysts’ consensus pretax and post-tax earnings estimates for companies in the S&P 500 Index for this year and the next four years, the longest period available in data compiled by Bloomberg. Using those numbers, I calculated each company’s implied tax rate and the rate for the broader S&P 500, weighting companies by their market value. And finally, I calculated each company’s post-tax earnings assuming a 15% and a 28% tax rate to see what the difference would be under each proposal.
The first thing to mention — because I sense that a lot of people are wondering to what extent the candidates’ tax proposals are already reflected in stock prices — is that the market does not appear to have digested the potential impact of new tax rates. The tax rate baked into the S&P 500 for this year is 20.4%, just a bit below the headline corporate tax rate of 21%. It’s roughly the same for each of the next four years.
Here’s where it gets interesting: It turns out that Trump’s proposed tax cut doesn’t move S&P 500 earnings in the early years, and it might even lower them further out. That’s because analysts already expect that the biggest companies in the S&P 500 will pay taxes at a roughly 15% rate, or even lower, over the next two years. That includes Apple Inc. and Nvidia Corp., the two most highly valued names in the index.
Further out in years three and four, however, applying a 15% tax rate would lower S&P 500 earnings by 5%, this time because many of the biggest companies would pay more in taxes. For example, analysts assume a 6% tax rate for Microsoft Corp. in fiscal years 2027 and 2028, and a rate closer to 10% for Nvidia and Alphabet Inc. in each of those two years. In aggregate, these three companies account for more than a tenth of the S&P 500’s pretax profits, so raising their taxes would have an outsize impact on the index’s earnings.
The effect of Harris’s proposal is more straightforward: Applying a 28% tax rate across the S&P 500 would lower the index’s earnings substantially, by about 15% in the early years and closer to 20% in years three and four.
Less obvious is the full impact on the market. Lower earnings usually result in a proportionate decline in stock prices. But it doesn’t end there because companies that make less are also less valuable. So, a decline in earnings would most likely be accompanied by lower valuations.
One way to gauge how much less is to look at the discount the market is offering for lower profitability. The S&P 500 Growth Index, for instance, is expected to generate a return on equity of 31% this year at a cost to investors of 32 times forward earnings. The S&P 500 Value Index, on the other hand, is expected to be a lot less profitable — a return on equity of just 13% — but also at the lower cost of 19 times forward earnings.
In other words, investors can pay 40% less for value stocks if they’re willing to accept 60% less profitability. With that as a guide, a 5% decline in earnings could be accompanied by a 3% decline in valuations, resulting in a total decline of roughly 8% for the S&P 500. Similarly, a 20% decline in earnings could entail a valuation contraction of about 15%, or a total market decline closer to 35%.
The details of Harris and Trump’s tax proposals — importantly among them the breaks and loopholes available to companies — will determine the actual rates companies pay. Those details won’t be known until a new administration takes office next year, so any initial market reaction is more likely to be based on the headline tax rates already proposed.
Even so, the market may not react to the election at all, preferring to wait until more details are available. I suspect that’s what it will do. But for those wondering how much the market could move in response to the candidates’ tax proposals, watch out for a modest correction if Trump wins and a deeper one if Harris prevails.
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To contact the author of this story:
Nir Kaissar at [email protected]