What are the potential impacts of tax and tariff policies on equity markets?

Tax and tariff policies significantly influence equity markets by affecting corporate earnings, investment strategies, and market sentiment.

With the 2024 U.S. presidential election approaching, analysts have been discussing the potential impacts of proposed policies from the leading candidates, Donald Trump and Kamala Harris, on equity markets.

Trump’s platform emphasizes tariffs as a revenue-generation tool to offset the extension of the Tax Cuts and Jobs Act (TCJA). However, analysts at Citi Research believe that current tariff proposals, if enacted, would not sufficiently offset the incremental funding gap created by extending the TCJA.

“However, de-regulatory and lower tax proposals are more equity friendly,” analysts added.

While higher tariffs may generate some revenue, they are unlikely to cover the cost of extending income tax cuts, which are projected to create a $4.6 trillion deficit over the next decade. This shortfall suggests that Trump’s policies, despite being more market-friendly due to lower tax proposals, may still struggle to fully support equity markets without further fiscal adjustments.

On the other hand, Kamala Harris’s platform suggests a continuation and expansion of existing policies, with a focus on higher corporate taxes to fund incremental spending programs.

Harris’s previous policy stances imply a significant risk to U.S. equity fundamentals, particularly if corporate tax rates rise from 21% to 35%. Such an increase would directly impact corporate earnings, reducing the free cash flow available for investments and shareholder returns.

In a hypothetical scenario where corporate tax rates are raised, the effective tax rate for companies could increase substantially, leading to additional tax payments and thereby reducing expected earnings per share (EPS) growth from 15% to 4% for 2026.

“While here we are just examining the potential EPS impact, investors will need to think of this as $335bn in FCF flowing to taxes instead of to capex/capital returns, etc,” the note writes.

Both candidates’ policies highlight the critical role of Congress in shaping the final impact on equity markets. A unified Congress, whether under Republican or Democratic control, could facilitate the enactment of more comprehensive tax and tariff policies. In contrast, a split Congress would likely lead to gridlock, complicating the implementation of significant policy changes.

Citi stresses the importance of considering the domestic versus international split in pretax income when assessing the implications of higher tax rates. Companies with a higher percentage of pretax income booked domestically are more vulnerable to changes in U.S. tax policy. For instance, small and mid-cap companies (SMID) tend to face higher tax rates compared to large-cap companies, making them more susceptible to the adverse effects of higher corporate taxes.

Moreover, the analysis notes that while tariffs are a key revenue-raising initiative in Trump’s policy platform, they may not be sufficient to replace income taxes entirely.

The relationship between higher tariff rates and lower import volumes suggests that increased tariffs could dampen import activity, limiting the potential revenue gain. This interplay between tariffs and trade volumes introduces additional uncertainty into the market, as global supply chains adjust to new tariff structures.