Some believe we may be on the verge of a new tax era where the lower tax rates of the past 30-years will subside, possibly reducing corporate profits, but providing much needed support for currently underfunded public programs like Medicare and Social Security. The Federal Reserve recently issued a white paper, End of an Era, highlighting some of the interest rate and corporate tax rate trends which have created strong corporate earnings, despite declining GDP (Gross Domestic Product), a measure of economic growth.[i] Logic would tell us that if the U.S. economic growth shrank from 7.63% to 4.68% in the last 30 years, corporate earnings should follow suit, but the opposite happened. The Fed attributes the inconsistent growth of corporation earnings from 7.24% in 1989 to 7.76% in 2023 to favorable low corporate tax rates and a coincidentally low interest rate environment.[ii]
The effective corporate tax rate fell from 44% during 1962-1982 to 34% during 1989-2007, and then 21-35% under Trump’s Tax Cuts and Jobs Act of 2017. Author Smolyansky estimates that the corporate growth rate would have shrank from 7.24% to 4.5%, similar in pattern to the GDP decline over the same 30-year window, had it not been for the reduced tax expense.
Understanding how these factors have benefited corporations is important, but what may be more pressing is how these changes may affect our future. Sustaining these low corporate tax rates in the future is unlikely. The administration voted into office in 2024 will determine how quickly tax rates change. Further, the Fed has already made adjustments to increase the Fed Funds Rate from the unprecedented 0% in 2008 and 2020, to a target range of 5.25%-5.5% today.[iii] Likely this will mean that corporate growth rates (and the stock market) will slow and more closely align with GDP growth rates. Higher stock valuations may be retained for corporations with strong financials rather than just future potential. Reach out to your Certified Financial Planner™ or CPA with a Personal Financial Specialist credential to adequately prepare your portfolio for whatever market lays ahead.