Fiscal Policy | Politics & Geopolitics | US
The odds of a Democrat sweep in November have recently risen from 35% to about 60%
A Biden presidency would warrant lower equity prices, all other factors equal
Relative sector prospects would shift a lot, and that has shown up in recent pricing
A key policy thrust would be to boost wages relative to profits
The US presidential election is now just over 4 months away. The race is between incumbent Republican Donald Trump and Democratic former vice-president Joe Biden. A Trump re-election would imply a continuation of the (albeit very volatile) status quo. For financial markets, a Biden victory would imply more change.
The evolving pandemic and enormous policy response make a consideration of what new plans might be adopted after January 2021 even more uncertain than usual. The ongoing Covid-19 response could dominate all other policy considerations. Biden’s platform will be more explicitly fleshed out at the Democratic Party Convention, due to be held in Milwaukee, Wisconsin, from 17-20 August.
On balance, I would judge Biden’s policies (if enacted) as negative for equities. First, his plans would involve higher taxes on businesses. Second, his policies would bolster wages (support for unions and minimum wage hikes). Finally, he is likely to toughen anti-trust (monopoly) enforcement, which could put downward pressure on profit margins. In light of all this, it is interesting that the equity market has apparently remained unfazed in June by Biden’s rise in the polls and betting markets (Chart 1).
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- The odds of a Democrat sweep in November have recently risen from 35% to about 60%
- A Biden presidency would warrant lower equity prices, all other factors equal
- Relative sector prospects would shift a lot, and that has shown up in recent pricing
- A key policy thrust would be to boost wages relative to profits
The US presidential election is now just over 4 months away. The race is between incumbent Republican Donald Trump and Democratic former vice-president Joe Biden. A Trump re-election would imply a continuation of the (albeit very volatile) status quo. For financial markets, a Biden victory would imply more change.
The evolving pandemic and enormous policy response make a consideration of what new plans might be adopted after January 2021 even more uncertain than usual. The ongoing Covid-19 response could dominate all other policy considerations. Biden’s platform will be more explicitly fleshed out at the Democratic Party Convention, due to be held in Milwaukee, Wisconsin, from 17-20 August.
On balance, I would judge Biden’s policies (if enacted) as negative for equities. First, his plans would involve higher taxes on businesses. Second, his policies would bolster wages (support for unions and minimum wage hikes). Finally, he is likely to toughen anti-trust (monopoly) enforcement, which could put downward pressure on profit margins. In light of all this, it is interesting that the equity market has apparently remained unfazed in June by Biden’s rise in the polls and betting markets (Chart 1).
Source: Suttle Economics
There are many moving parts to the equity market, and some would argue that its recent strength underlines a belief that whoever is in power will choose to adopt very stimulative monetary and fiscal policy to fend off the effects of Covid-19. Democrats moved into the lead on presidential election betting in early March (Chart 2). The sectoral performance of the equity market since then is consistent with the pattern of likely winners and losers under a Biden presidency, suggesting that market pricing is indeed very attune to the outcome of the event (Chart 3).
Source: Suttle Economics
Source: Suttle Economics
Election Odds Re-assessed and Still Volatile
Trump’s re-election odds peaked most recently at about 60% in late February. Since the onset of Covid-19, however, those odds have fallen and are now about 42%. A long-standing election model developed by Ray Fair gives most significance to economic conditions during the election year. These will end up being highly volatile: favourable to Trump through February; very adverse from March through early summer (late Q1 and Q2); likely more favourable in Q3, albeit with a growing risk of relapse. Q2 GDP data are likely to show the weakest quarterly growth rate on record, to be followed in Q3 by the strongest. The Q3 GDP data are due for release 5 days before the election.
Approval ratings at this stage of the presidency provide an additional guide to the likely election outcome (Chart 4). Trump’s net (dis)approval ratings have been remarkably stable through his first 3½ years in office, although the current net negative rating of -14 is at the lower end of the range. Trump is currently closer to Bush 41 and Carter (both one-term presidents) rather than Bush 43 and Obama (both of whom earned re-election).
Another election factor of growing importance is the outcome of congressional races, especially those for the Senate (Democrats are very likely to retain their House majority). In recent months, the odds of the Democrats winning a majority in the Senate have risen from 30% to 60%. If Biden wins the presidency, a net gain of 3 Senate seats would be needed to win a Senate majority; if not, then a pick-up of 4 would be required. As in 2009, a sweep would give Democrats the ability to enact a new policy agenda although the first priority would be handling the inherited crisis.
Source: Suttle Economics
Source: Suttle Economics
Biden’s Tax Policy Proposals
Biden’s tax proposals are best viewed as a partial unwind of the tax cuts enacted under the 2017 Tax Cuts and Jobs Act (TCJA). Under the proposals, the amounts raised from individuals and business income tax would be relatively similar, according to independent studies done by the Tax Policy Center (TPC) and the American Enterprise Institute (AEI). Averaging the two studies, the net average annual tax increases in 2021-22 would be $157 billion on households (Chart 6) and $158 billion on businesses (Chart 7). The combined average of $315 billion would amount to about 1.5% of GDP. From a macro perspective, most of that tightening would come in 2021 (about 1 percentage point), with another ½pp or so in 2022. Raising taxes so early in a recovery might be reconsidered post-election, in my view.
Source: Suttle Economics
Source: Suttle Economics
While the incidence of higher tax would be broadly split among households and businesses in dollar terms, the proposed increases would increase the corporate tax burden by far more than that for individuals. In 2019, corporate taxes were $230 billion; individual income taxes were $1.7 trillion. Taxes collected from corporates fell by 41% from $344 billion in 2015 to $205 billion in 2018 as the benefits of the TCJA flowed through. The Biden proposals would unwind much of this EPS bottom line benefit.
Trump’s tax measures have been regressive (income tax breaks mainly for the better-off and higher tariffs). The Biden household tax measures would be heavily progressive, with higher taxes on individuals earning more than $400k per year (Chart 8). Higher taxes on businesses would result mainly from an increase in the statutory minimum rate, from 21% under the TCJA to 28% (Chart 9). Other notable business tax measures would be an effort to reduce the effective low tax rates that technology and pharmaceutical firms pay by booking their earnings offshore, and a measure to eliminate tax breaks for commercial real estate.
Source: Suttle Economics
Source: Suttle Economics
Spending Policies: Cut Defence, Raise Non-defence
Shifts from Republican- to Democratic-controlled governments tend to have predictable effects on both the growth rate and pattern of federal spending. Republicans love to spend, while Democrats are typically more cautious (Chart 10). Since 1980, the overall (nominal) annual growth rate of federal spending has averaged 6.3% under Republican presidents (23 years) and 1.2% under Democratic presidents (16 years). Two factors seem to account for these differences. Most importantly, Republicans like to spend on national defence, while Democrats typically cut it. Democrats also raise non-defence discretionary spending by less than Republicans and this reflects congressional realities: Democrats often face a divided/opposition Congress; and Republicans are usually willing to trade higher non-defence discretionary spending to get what they want on defence. A Biden presidency would therefore suggest a reversal in the growth of defence outlays and a modest boost to non-defence outlays.
Source: Suttle Economics
Covid-19 has upended budget policy in 2020. The significant divisions evident between the Republican Senate, which has favoured transfers to businesses and the Democrat House, which has emphasized transfers to (lower-income) households, the unemployed and states underline that the election could significantly affect the pattern of spending in 2021 and beyond. The election outcome is likely to have significant implications for the municipal bond market (positive under a Biden win).
Three other aspects of the Biden spending program are important. All reflect pressure that the relatively moderate Biden faces from more progressive candidates to the left that he beat in the primaries. First, he would favour an extension of the Affordable Care Act so as to provide comprehensive coverage (including a further increase in Medicaid). This would add about $75 billion per year (0.4% of GDP) to spending over 10 years. Second, he would promote more spending on education, including student loan relief. The plan that he adopted in April would similarly add about $75 billion a year to outlays over 10 years. Finally, he has outlined an infrastructure plan (costed at $1.3 trillion over a 10-year horizon).
Sectoral, Labour Market and Competition Policies
One aspect of Biden’s infrastructure program is that it would promote ‘green’ causes (including low-carbon public transit). A Biden presidency would likely re-regulate parts of the fossil fuel industry, adding to the problems of a sector already reeling from a shake-out after a phase of rapid, leveraged expansion. Similarly, Biden’s policies might be expected to worsen the difficulties facing commercial property, including the tax measures already noted. The financial sector would likely experience a new wave of regulatory pressure. Large banks will come under scrutiny from anti-trust authorities. Non-bank financial institutions – especially private equity – will see some of their advantages disappear, dampening that source of equity demand. More generally, companies are likely to come under pressure to rein in equity buybacks. Less preferential tax treatment for capital gains would also push in that direction.
A Biden presidency – especially one accompanied by congressional majorities – would make a push to reverse the trend to rising inequality in income in the United States for the past 50 years under both parties (Chart 11). Trump tried an approach based around populism and protectionism, while adding to inequality through his fiscal policy. For Biden, a more progressive tax policy will be a key aspect of this push (no new wealth tax is likely). He has a plan to raise the federal minimum wage from $7.25 to $15 per hour. He also plans to revive union membership and bargaining power, as well as to restrict employer collusion to hold wages down (e.g. non-poach policies among franchisers). The more business-friendly anti-trust policy adopted under Bush 43 and renewed under Trump would also change, likely weighing on anti-competitive behaviour and profit margins.
Source: Suttle Economics
Phil Suttle is the founder and principal of Suttle Economics.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)