Investors have had their eyes on the Federal Reserve and what its interest-rate decisions mean for stock markets.
They had better watch the Internal Revenue Service and Treasury Department, too, because a new analysis suggests that the more money tax payments soak up, the less money will be free for stock purchases. At a time when people are wrapping up their 2023 taxes and starting to pay their 2024 taxes, that could crimp the S&P 500’s
SPX
efforts to keep scoring new highs.
That’s according to an analysis this week from Tom McClellan, editor of the McClellan Market Report.
“Paying more in taxes means that the extra money people have had is not going to be around any more to help lift the stock market, and instead Uncle Sam (and Janet Yellen) will have it,” McClellan said in his note. “That’s good for the nation’s accumulating debt, but not for the path of the stock market.”
In fact, when tax revenue creeps past a certain share of GDP, that’s not good for the economy either, he added. Then people could be staring down a recession, McClellan said.
The federal revenue from individual income taxes, payroll taxes, corporate taxes and other taxes equaled 16% of gross domestic product in fiscal year 2023, according to Treasury Department numbers.
But when taxes account for 18% of GDP, McClellan said, that can be a signal of a looming downturn.
“If 2024 brings a combination of rapidly rising tax collections and a slowing economy, then this tax receipts to GDP ratio could quickly jump up close to that 18% threshold, making things much more difficult for the stock market,” he wrote.
The federal government pulled in $1.58 trillion from tax revenue and other sources between the October start of its fiscal year and January, according to the Treasury Department. That’s a roughly 8% increase from the same timeframe a year earlier.
There’s a range of takes on the interplay between tax payments and stock performance. And, of course, taxes are one gust in the tailwinds and headwinds pushing equities higher and lower. Don’t forget the big push that could come from a Fed rate cut, whenever that may occur. But take a step back to understand what could be ahead for taxes and investments.
There’s a lag between tax-collection amounts and stock-market performance, McClellan said. Estimated tax payments trail by a quarter, and then by Tax Day on April 15, households square up whatever else they owe to the government.
This tax season, investors are filing returns on their earnings and capital-gains income from 2023 — which was a rebound year for markets after 2022’s dismal showing.
The link matters because, in this context, “it says that federal tax collections should start rising rapidly, a rise which should last for at least the next 12 months, since the S&P 500 has just made new all-time highs,” McClellan said.
Because of IRS rules on minimum amounts to pay before Tax Day, McClellan said, an investor who watched the market pummel their portfolio in 2022 might have paid lower quarterly tax payments through 2023.
“And now that taxpayer is likely going to be reporting a gain for 2023, which will drive up the quarterly estimated payments in 2024,” he said.
The next big question is how much the economy grows with those increasing tax payments. If it grows in tandem, that’s fine. But if GDP slows while tax collections climb, McClellan said, investors face “a condition where this ratio changes quickly to a very adverse one for stock prices.”
Investors face another lurking question on taxes: What will the tax code even look like after 2025? Starting then, most of the 2017 Donald Trump-era tax cuts expire, including key rules and rates for individual income taxes.
For example, the rates on five of seven tax brackets would increase without congressional action.
Individual income taxes have produced $808 billion, or 51% of federal revenue, so far in the government’s fiscal year, Treasury data shows.
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