Investors have been watching the Federal Reserve and what its interest rate decisions mean for stock markets.
They better keep an eye on the Internal Revenue Service and the Treasury Department, too, because new analysis suggests that the more money tax payments absorb, the less money there is to buy stocks. As people finish their 2023 taxes and start paying their 2024 taxes, that could hamper the S&P 500's efforts to continue setting new highs.
That's according to an analysis this week by Tom MacLellan, editor of the MacLellan Market Report.
“Paying more taxes means that the extra money people earned will no longer be there to help lift the stock market, and will instead be given to Uncle Sam (and Janet Yellen),” McClellan said in his memo. “This is good for the country's accumulated debt, but not for the stock market's trajectory.”
In fact, when tax revenues exceed a certain share of GDP, it is not good for the economy either, he added. People may then face a recession, McClellan said.
Federal revenues from individual income taxes, payroll taxes, corporate taxes and other taxes reached 16% of GDP in fiscal year 2023, according to Treasury Department figures.
But when taxes represent 18% of GDP, McClellan said, that could be a signal of an impending decline.
“If 2024 brings a combination of rapidly rising tax collections and a slowing economy, the ratio of tax revenues to GDP could quickly jump near the 18% threshold, making things even more difficult for the stock market,” he wrote.
The federal government withdrew $1.58 trillion in tax revenue and other sources between the start of its fiscal year in October and January, according to the Treasury Department. This represents an increase of approximately 8% from the same time frame a year ago.
There are a range of interactions between tax payments and stock performance. Of course, taxes are one of the tailwinds and headwinds that push stocks up and down. Don't forget the big boost that could come from a Fed rate cut, whenever that happens. But take a step back to understand what could happen in the future for taxes and investments.
McClellan said there is a gap between tax collection amounts and stock market performance. Estimated tax payments are delayed by a quarter, and then by Tax Day on April 15, families settle anything else they owe to the government.
This tax season, investors are offering returns on their dividends and capital gains income from 2023 — which was a rebound year for markets after 2022's dismal performance.
McClellan said the link is important because, in this context, it “suggests that federal tax collections should begin to rise quickly, a rise that should continue for at least 12 months, given that the S&P 500 has just reached record highs.” “Launching.” .
Because of IRS rules about minimum amounts to be paid before tax day, an investor who watched the market hit his portfolio in 2022 may have made lower quarterly tax payments through 2023, McLellan said.
“Now taxpayers will likely report gains for 2023, which will lead to increased estimated quarterly payments in 2024,” he said.
The next big question is how much the economy will grow as tax payments increase. If it grows side by side, that's okay. But if GDP slows as tax collections rise, investors face “a situation where this ratio changes rapidly to a very negative ratio to stock prices.”
Investors face another lurking question about taxes: What will the tax code look like after 2025? From then on, most of the 2017 Donald Trump-era tax cuts expire, including the basic rules and individual income tax rates.
For example, rates would increase on five of seven tax brackets without action by Congress.
Treasury Department data show that individual income taxes have generated $808 billion, or 51% of federal revenue, so far in the government's fiscal year.
