Back to top

Image: Bigstock

Tax Hike Not a Big Concern? Play S&P 500 ETFs

Read MoreHide Full Article

After the passage of the $1.9-trillion stimulus bill that included the $1,400-stimulus check under the Biden administration, Wall Street is expecting a tax hike to hit the U.S. economy. A hefty stimulus has strengthened the expectation of enactment of the U.S. President Joe Biden’s other proposals at the time of election campaigning. Among many agendas, Biden had plans for tax hikes.

The President’s plan is to hike the corporate tax rate to 28% from 21%. He is also proposing to levy a minimum tax rate of 15% — a potentially damaging outcome for some major companies that pay little in taxes. And this new bill may come across as the first federal tax hike in nearly three decades as the new tax law is expected to include a corporate tax hike and an increase in the capital-gains tax rate.

How Worrisome Is It?

First of all, Centrist Democrats in Congress are opposing Biden’s corporate tax proposal, which is why Goldman Sachs strategists this week forecast that the corporate tax rate would be hiked to just 25%, below Biden’s proposed 28%, as quoted on barrons.com.

Coming to the capital gains tax, under Biden’s proposal, those earning $1 million or more annually would have to incur capital gains tax on stocks at 39% — the ordinary income-tax rate — versus the current capital-gains tax rate of 20%. Talks are on that there is a resistance from centrist Democrats which might make the actual rate well below 39%.

A Hike in Capital Gains Taxes Mean a Tepid Wall Street for Short Term

Increase in the capital-gains tax could result in a large-scale stock selloff, according to economic analyses, as quoted on CNBC. In 1986, as part of the Reagan tax plan, the top rate for capital gains surged from 20% in 1986 to 28% in 1987. Just before the hike, capital gains’ realizations shot up by 60%, the CNBC article noted. An overall stock market selloff means a short-term rough patch for the likes of iShares Core S&P Total U.S. Stock Market ETF (ITOT - Free Report) .

However, the hike in the same should not impact the markets over the long term. An increase in capital-gains taxes would surely impact stock-market valuations. Investors may only be willing to pay a lower multiple for near-term profits as the after-tax return would be lowered, per barrons.com article. But that should not suppress the entire market momentum.

In 2013, the S&P 500 added about 30% despite the nine percentage-point increase in capital gains tax rate. In 1981, the tax rate dropped about eight percentage points, but the S&P 500 skidded 10%, Barrons’ article noted.

Against this backdrop, below we expect the medium-to-long term bet on the S&P 500 ETFs to be worth. Given the rising virus cases in the United States and elsewhere and slowing economic reopening, the S&P 500 stocks look like better bets than the domestically focused small-cap index Russell 2000.

Plus, small companies – which are more domestically focused and have less foreign exposure – pay huge taxes in America. This is because these pint-sized companies can’t pile cash in foreign lands. Hence, the segment may fall prey to Biden’s prospective tax plan (read: ETFs at Risks If Tax Law Changes in U.S.).

Meanwhile, the tech-heavy Nasdaq is suffering from overvaluation concerns. Hence, one can place bets over the below-mentioned S&P 500 ETFs at the current level.Wall Street bull Ed Yardeni sees the S&P 500 year-end target as 4,300, suggesting an 8% gain from Friday’s close. For 2022, it’s 4,800, as quoted on CNBC.

ETFs in Focus

Vanguard S&P 500 ETF (VOO - Free Report)

iShares Core S&P 500 ETF (IVV - Free Report)

SPDR S&P 500 ETF Trust (SPY - Free Report)

SPDR Portfolio S&P 500 Growth ETF (SPYG - Free Report)

SPDR Portfolio S&P 500 Value ETF (SPYV - Free Report)

Want key ETF info delivered straight to your inbox?

Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>