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How Financial Downturns Can Be “Taxing” In More Ways Than One

One obvious way that a bear market can hurt financially is by delivering a decline to an equities-stuffed portfolio's value.

Also, history shows that big bear markets precede substantial slowdowns in the economy.

Here's what else to expect during the next major financial downturn: higher taxes.

As a case in point, Elliott Wave International's February Global Market Perspective discusses the United Kingdom. Here's a chart and commentary:

TaxHikes

Last October, the British government increased universal credit allowances, suspended minimum income floors, boosted benefit entitlements, and raised housing support for private renters. According to the Institute for Fiscal Studies, the "temporary giveaways" cost about £9 billion and pushed working-age benefit spending to its highest level on record. (IFS, 10/2020)

Tax hikes--one of the most common manifestations of a bear market--will come next. As this chart shows, both corporate and basic income taxes declined throughout the stock bull market, spanning both Conservative and Labour administrations. The arrow on the far left side of the chart points to the last time a Chancellor raised taxes. It occurred way back in 1975, when Labour's Denis Healey boosted the basic income tax rate on the heels of a two-and-a-half-year decline in the FTSE All-Share index.

Today, with the FTSE off 17% from its all-time high, a global pandemic has decimated the treasury, political speculation focuses on "how the country will manage the ballooning debt," and the UK media has been "rife with speculation that the government will try to swell its tax take." (Bloomberg, 1/23/21)

So far, historically accommodative credit markets (themselves a byproduct of positively trending social mood) have permitted governments to delay raising taxes.

Yet, when social mood shifts from positive to negative, the UK is expected to face a "reckoning," as mentioned in this Feb. 15 Yahoo! Finance article excerpt:

The UK government has been warned it could be forced to hike taxes by £60bn ($83.4bn) a year to fill a black hole in the public finances caused by COVID-19.

A leading think tank said the UK will likely face a "reckoning" with the economic cost of COVID-19 in the years to come, in the form of tax increases just to cover day-to-day spending.

New analysis suggests the long-term economic damage of the pandemic and higher spending pressures will leave "ongoing unsustainable deficits" in the public finances even as the economy recovers. GDP is expected to still be 3% below its pre-virus level at the end of the year.

Borrowing in 2020-21 will reach its highest ever share of national income outside the two world wars, according to new analysis by the Institute for Fiscal Studies (IFS) and Citi Research. Even in 2024, the figures suggest borrowing between £50bn and £190bn will be needed to fill a funding gap in everyday spending.