What Are the Potential Impacts of Tax and Tariff Policies on Equity Markets?

Tax and tariff policies play a crucial role in shaping equity markets by influencing corporate earnings, investment strategies, and overall market sentiment.

As the 2024 U.S. presidential election draws near, analysts are examining how the proposed policies of leading candidates Donald Trump and Kamala Harris could impact equity markets.

Donald Trump’s platform prioritizes tariffs as a means to generate revenue, aiming to mitigate the financial implications of extending the Tax Cuts and Jobs Act (TCJA). However, analysts from Citi Research contend that the current tariff proposals, if implemented, would not adequately close the funding gap created by the TCJA extension.

Despite this, they noted that deregulation and lower tax proposals are generally more favorable for equity markets. Although higher tariffs might yield some additional revenue, they are expected to fall short of covering the costs associated with extending income tax cuts, which are anticipated to result in a $4.6 trillion deficit over the next decade. This suggests that while Trump’s policies may be more beneficial to the markets through lower tax proposals, they may still face challenges in fully sustaining equity markets without further adjustments.

Conversely, Kamala Harris’s platform advocates for the continuation and expansion of existing policies, focusing on increasing corporate taxes to fund additional spending initiatives. Her past policy positions indicate a potential risk to U.S. equity fundamentals, particularly if corporate tax rates were to rise from 21% to 35%. Such an increase would directly affect corporate earnings, leading to a decrease in free cash flow available for investments and returns to shareholders.

In a scenario where corporate tax rates increase, the effective tax rate for companies could rise significantly, resulting in higher tax obligations and a potential drop in expected earnings per share (EPS) growth—from an estimated 15% down to 4% for 2026. Analysts highlighted that this shift could translate to a substantial $335 billion in free cash flow redirected to tax obligations rather than capital expenditures or returns.

Both candidates’ policies underscore the essential role of Congress in determining the ultimate effects on equity markets. A unified Congress, whether led by Republicans or Democrats, could enable the passage of more comprehensive tax and tariff measures. Conversely, a divided Congress would likely lead to legislative gridlock, complicating the implementation of significant policy changes.

Citi emphasizes the need to consider the distribution of pretax income between domestic and international markets when evaluating the implications of higher tax rates. Companies generating a larger share of pretax income domestically tend to be more exposed to fluctuations in U.S. tax policy. For instance, small and mid-cap companies typically face higher tax burdens compared to their large-cap counterparts, making them more vulnerable to the negative impacts of elevated corporate taxes.

Additionally, while tariffs are a central revenue-raising component of Trump’s policy approach, they may not fully compensate for income taxes. The correlation between higher tariffs and reduced import volumes indicates that increasing tariffs could suppress import activity, thereby limiting potential revenue gains. This dynamic between tariffs and trade volumes adds further uncertainty to the market as global supply chains adapt to new tariff frameworks.