The U.S. has been spending freely this past year in order to stimulate their economy. The big question for many became, how will all of this be funded? There were rumors that it would be funded through increased corporate and capital gains taxes which was later confirmed in President Biden’s latest plans. In the first instance we might think that increased corporate taxes would be bad for the companies we own. According to Finance Professor Aswath Damodaran, this is not necessarily the case. There are more factors that should be considered. For instance, a higher corporate tax rate can give companies the opportunity to report less income taxable income and defer more taxes to future years. In other words, world governments often overestimate the amount of revenue they will receive with increased taxes.
We must also take account contemporaneous changes in the tax code (i.e., limits on tax deductibility of debt) and financing mix. Because interest on debt is tax deductible, an increase in corporate taxes means a decrease in after-tax cost of debt. In layman terms, it will cost less for companies to borrow money. What we want to leave you with is this; An increase in marginal tax rate does not necessarily equate to an increase in effective (actual paid) tax rate. While an increase in corporate tax rates can adversely impact some companies, there are others that can actually benefit from such a scenario.