All things being equal, higher taxes on corporations would be a headwind for earnings growth.
And while worries about this risk are likely to linger, it's far from certain that expectations for — and the implementation of — higher taxes would be a reason for the stock market to turn lower.
For starters, the prospect for higher taxes is a known risk.
According to Bank of America's Fund Manager Survey released last Tuesday, higher taxes are already being identified as the "biggest tail risk" by more respondents than those flagging COVID-19.
Similarly, a survey of RBC Capital Markets' analysts in mid-March revealed "corporate/individual tax increase or tax code changes" as the policy area analysts are "most excited about/worried about."
In other words, the realization of higher taxes wouldn't be a total surprise as it is already high on the pros' lists of things to watch out for. Remember: it is the risk no one is talking about that tends to bring the most volatility when it surfaces.
Second, higher taxes aren't expected to put an end to corporate earnings growth.
BofA equity strategists recently unveiled their outlook for S&P 500 earnings in 2022. The headline: "Launching 2022 EPS at $205 (but $14 at risk of tax hike)."
In their baseline scenario, BofA sees S&P 500 EPS surging 32% to $185 in 2021, and then jumping 11% to $205 in 2022.
Assuming tax hikes, those numbers come down to $162 and $188, respectively. BUT while those numbers are lower, they still reflect growth.
Third, there's evidence that markets are already adjusting for high taxes.
In a recent note to clients, RBC Capital Markets' Lori Calvasina analyzed the performance of stocks at various levels of effective tax rates. In theory, companies with higher effective tax rates should outperform when taxes are expected to be lowered and underperform when taxes are expected to be hiked.
"To understand to what extent Trump’s tax reform, and the possibility of higher corporate taxes under Biden, has been getting expressed in stock market performance, we ranked all of the stocks in the Russell 1000 by the gap in their average effective tax rates in 2018-2019 and 2016-2017," she wrote.
"We found that the Large Cap stocks with the biggest declines in their effective tax rates outperformed from 2016 through mid 2019. Performance was choppy from late 2019 through 2020, and underperformance has been seen since late February 2021. When we replicate this analysis for the Russell 1000 sectors, we find that most also saw some degree of outperformance by the stocks that experienced the biggest declines in their effective tax rates under Trump, and have experienced underperformance and/or choppiness in more recent trading."
In other words, Calvasina suggests that the stock market's climb to new highs has come with investors rotating and repositioning for tax hikes.
While it remains unclear what kinds of new taxes corporations may face, financial market professionals are already raising concerns, Wall Street experts are already modeling potential costs, and the market already seems to be pricing in potential changes.
This article originally appeared on Yahoo! Finance.
