Stocks buckled in the immediate aftermath reports that the Biden administration planned to nearly double the capital gains taxes on the wealthy, with the S&P 500 falling as much as 1.2% before clawing back some losses.
Still, the decline was minor next to the index’s 85% return over the last 13 months, and most institutional investors said they’d wait to see how the bill progressed before doing anything rash.
News of Biden's proposed tax hikes really shouldn’t have been a surprise on Wall Street - it’s the same increase laid out in platforms released during the presidential campaign, and copious analysis had already been published prior to Thursday.
At Goldman Sachs, strategists led by David Kostin wrote as early as October that raising the tax rate would be a “minor speed bump for the upward trajectory of stock prices” that would shortly give way to fresh gains,
“History shows stock prices fall, equity allocations decline, and momentum underperforms ahead of increases in the capital gains tax rate.”
“However, any potential equity selling will be short-lived and reversed in subsequent quarters.”
Logically, Goldman Sachs says, stocks that have gained the most may get hit hardest in the short-term drawdown and would include companies like Tesla (-3.28%) with its 400% gain in the past year, along with the FAANG block of megacap tech shares that carried the market off the pandemic lows.
Goldman Sachs estimated in October that the top 1% of households have around US$1 trillion of unrealized capital gains.
In 2013, that cohort sold “1% of equity, their starting equity assets, which would equate to around US$100 billion of selling in current terms,” according to the Goldman Sachs strategists wrote.
The group then turned around and bought the equivalent of 4% of holdings once the tax took effect in 2013, Goldman Sachs said, more than offsetting the selling.
Regardless, momentum stocks could still feel the brunt of any major tax hike, just as they did in 1986, when the tax rate on long-term capital gains rose to 28% from 20%.