Rising government spending of all sorts has been good for Wall Street thus far. It has helped raise household incomes and expenditures, as evidenced by recent macroeconomic indicators.
Personal income jumped 21.1% month over month in March, rebounding from a 7% drop in February. It was the most significant rise on record, reflecting an increase in government social benefits as most Americans received stimulus checks under The American Rescue Plan Act.
Personal spending increased 4.2% from March, the most significant increase in consumption since June 2020, as households received an additional round of direct economic impact payments from the government.
Higher household expenditures, in turn, have translated into higher sales for listed companies, boosting their top and bottom lines.
S&P 500 companies have reported the highest earnings growth since 2010, according to FactSet, which is keeping tabs on the first-quarter earnings season.
But growing government spending must be paid for either by the government issuing more debt and raising taxes.
Both options are bad for the economy and bad for Wall Street, especially higher corporate taxes.
They are bad for the economy because of the "crowding out" effect. That's the negative impact of corporate taxes on corporate investments, as corporations hand a chunk of their earnings to government bureaucrats to invest rather than plowing into their projects.
Simply put, government dollars boost economic activity and jobs in one area of the economy while depressing them in another.
Meanwhile, rising corporate taxes are bad for Wall Street because they reduce the cash flow to stockholders and, therefore, shave off every profitable listed company's intrinsic value. "Higher tax rates mean lower earnings," Quo Vadis President John Zolidis said. "Higher tax rates also reduce a company's economic return. A business' economic return (how much value it creates for shareholders) determines in part what multiple it should trade relative to earnings. A lower return equals a lower multiple. Thus, higher tax rates for corporations will result in lower earnings (the 'E') and also justify a lower earnings multiple (how you get to the 'P' in the price to earnings ratio (PE)."
Simply put, higher corporate taxes equal lower equity prices.
While it is still unclear which taxes the government will hike and how much, one thing is clear: Wall Street should begin factoring in higher taxes in its valuation models. And that isn't a positive thing for equities in the future.
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