March 1, 2021
After a year like 2020, what if all the turmoil brought us to an opportunity for significant economic growth?
In Ronald Blue Trust’s recent webinar, “New Administration Tax Plan 2021,” our Head of Investments, Brian McClard, and Head of Estate/Trust Planning, Alan Cox, spoke about the economic outlook under the new administration and pointed out several indicators that are surprisingly positive. Here are some insights from their discussion:
Many investors have taxes on their mind, and taxes are definitely a priority for the current administration. It appears tax hikes are planned across the board and while they’re a priority, they’re not the administration’s first priority. In the near term, the likelihood of tax increases will be tempered based on the path of the economy’s recovery and the amount of stimulus that is provided to offset these increases. The Biden administration has enacted a “do no harm to the economy” mandate.
Longer term, no matter how you look at it, tax increases seem almost inevitable given the government’s pace of debt accumulation and what we’re seeing with the worsening fiscal situation.
So, what’s the impact to investors? It will depend on what legislation is passed. There are still a lot of unknowns but let’s look at history as a guide. In terms of capital gains taxes, history shows that there is an inverse relationship between capital gains and the realization of those capital gains. Investor behavior becomes a very important component of how this plays out. Historically when taxes rise, investors slow the realization of those gains, and when taxes go down we’ll see investors typically accelerate those gains. Investor behavior is important as it relates to capital gains.
The predicted increase of corporate tax rates back to 28% are estimated to affect companies’ bottom lines. That outcome will impact different sectors of the market differently, but we could see an average hit of 7%. However, the U.S. has operated at higher corporate tax rates before, even in productive growth environments. Plus, corporations have not been using their tax savings to invest in new projects, but instead they have been buying back stock, which is a function of the current investment environment that we have.
A study by Fidelity shows that when we look back at the last 13 tax increases across corporate, personal, and capital gains rates from 1950 until now, we see that in every instance except one, stocks were actually higher. Our previous evidence suggests that taxes alone aren’t really enough to tank the market, although they are important.
There are a lot of tailwinds to economic growth coming into this year. Consensus, real economic growth is estimated at 4% for the U.S. in 2021. Now some companies like Goldman Sachs and PIMCO are actually estimating that growth could be as high as 6-7% and that would show solid growth. To give you some context, we’ve not seen a consistent 4% growth rate since the 1990s, and for the last two decades, real growth has averaged only about half that–roughly 1.9% per year. This data is significant, but it also suggests that we’re going to have a hard time staying at that higher growth rate. Something else would have to kick in if we want to achieve a sustained rate at that level.
Reasons for optimism
Potential reopening tops the list of reasons for optimism, along with hopeful success of the distribution and effectiveness of the COVID-19 vaccines. Last year, corporate earnings were down about 16% year-over-year. Analysts expect that earnings per share could top 20% this year.
Consumers also are in a good shape. They have their strongest balance sheet since 2000. Compared with the financial crisis of 2008 when consumers were coming out of the recession and still trying to repair their balance sheet, they now have excess personal savings that could come into the economy. There’s the wealth effect from the housing boom that’s taken place and then another material factor is the accommodative monetary and fiscal policies. This growth backdrop will shape what policies materialize out of Washington.
For now, the main policy implications are centered around supporting the economy in the form of fiscal policy facilitating consumption and monetary policy facilitating asset prices. Last year, we had half of the S&P 500 returns coming from just six stocks. A broader economic recovery could mean there’s a continued rotation into broader segments of the market that haven’t done as well in recent history.
The Fed has effectively lengthened the investment horizon by lowering interest rates and therefore, there is the distinct possibility that we can expect lower returns for asset classes going forward. In turn, investors should lengthen their time horizon if they can. They could accomplish this goal by working longer, saving more, spending less, or thinking about their investments differently.
Perhaps instead of investors evaluating their long-term investments on a year-to-year basis, they could think about them in terms of a decade at a time. Secondly, investors should diversify in a way that acknowledges future policy uncertainty and prevents over-weighting on scenarios that may never come to pass. For instance, they might consider diversifying by time-based buckets based on what they’re trying to accomplish and when with their financial goals.
To learn more information about the tax and economic implications of the new administration, view our full economic review and outlook report here.
At Ronald Blue Trust, we believe that the best tax planning is done throughout the year. Please contact your tax preparer or financial advisor to determine if any of the above strategies based on our biblical financial approach could be appropriate for you. If you need assistance and would like to talk to a Ronald Blue Trust advisor, please contact us at 800.987.2987 or email [email protected].