With the upcoming election, I know that there are many more implications than just money. There are obviously political, health, and social issues that are critical and in our face every day. I honestly wouldn’t know where to begin with those and I only really named a few to begin with. So instead, I will do my best to present the facts on important financial policies with some educated guesses mixed in.
Federal tax rates on corporate and individual income were both cut under the Trump Administration. Some personal deductions were eliminated and high-tax states were hurt with the State and Local Tax (SALT) deductions being capped at $10,000. However, most taxpayers still came out ahead thanks in part to their lower tax rate and higher standard deductions.
Joe Biden has proposed several tax hikes that are mostly focused on those households making $400,000 or more and on corporations. Biden has proposed bumping the top individual tax rate back to where it was at 39.6% and treating capital gains and dividends as ordinary income, which were previously capped at 20%. Additionally, his plan includes removing the Qualified Business Income tax deduction for pass-through business owners (partnerships, LLCs, S-Corporations, and sole proprietors).
Under another term with Trump, we’d likely see a continuation of the current tax code without too many more significant changes. He already completed the biggest shakeup in three decades. There had been some talks of further tax cuts but that will be difficult to accomplish with a rising federal deficit from coronavirus stimulus packages. That has to get paid back somehow. As things stand currently, individual tax rate cuts are set to go away in 2025. A lot can happen between now and then but their expiration was originally written into the tax code overhaul. The individual tax cuts are not expected to go on forever. The corporate tax cuts were written into law as indefinite.
Stock Valuations & Bond Market
If Biden wins, stock valuations would immediately be lowered because these companies would simply be paying more corporate tax. That’s just a fact. The book value of stocks would be less. However, book value and actual market value are two separate things. It is hard to imagine that a 7% tax increase itself being so destructive as to cause a serious stock market crash. Even if Biden does get his way, the corporate tax rate would still be 7% lower than where it was when Trump took office. To be clear, Trump cut the corporate tax 14% and Biden’s proposal would split the difference.
On the fixed-income side, no matter who is President — interest rates are projected to stay low. Very low. They are the lowest in history right now but the Federal Reserve does not have much of a choice as they try to stimulate the economy during unprecedented times. We might not be able to earn anything decent on our savings accounts and our expected bond returns are lower but you can use these rates to your advantage too. On the borrowing side, there are options to refinance an existing mortgage, buy a new home, or open a home equity line of credit. Many are doing so as lenders have been slammed with business.
For those still in the workforce, contribution limits to retirement plans such as a 401(k) have been consistently raised over the years, which is a great thing for investors and those with excess income. Trump continued this tradition with an increase last year. Employees stash this money away, invest it, and defer it from income tax. High-income earners benefit more from retirement plans because they are avoiding tax in a higher marginal tax bracket than someone that earns less. Naturally, these are usually the same people that can afford to max out their plans and save more too.
Biden is looking to make a pretty substantial change here and just provide a flat tax credit up to a speculated amount of 26% that he claims would even things out more. There could be a scenario where a high-income earner is putting money into a 401(k) and part of that contribution would still be taxed as income. Then, it would be taxed again upon withdrawing it later in life — double taxation. My initial read is that if this is implemented as-is, Roth 401(k) accounts will become more popular — pay the tax upfront and never again.
For retirees, there are two key things to be made aware of. Biden is looking to eliminate the step-up cost basis altogether. This means that when your non-spouse beneficiaries inherit non-qualified assets, they would owe tax on the gains upon sale just like you would have if you were alive. The current law raises the cost basis to match the market value upon the date of your death. So, if a non-spouse beneficiary would sell at that time, no tax would be owed. Additionally, Biden wants to lower the estate tax exemption limit from $11.58 million back to $5.79 million. Anything inherited above that level would be taxed. This is a limit that Trump had raised previously.
We have reached the part of this analysis where we will only truly get our answers with time. I’m sure everyone has their opinion on the matter but it’s our job not to let our political beliefs negatively impact our investment decision-making. The wrong call can set us back years.
What will another term of the Trump administration look like for the economy? Well, we were on an excellent trajectory before COVID-19 hit. Deregulation and lower taxes certainly helped growth across the country. If the virus is under control next year, I see no reason why this would not pick back up. Will we finally see an infrastructure plan pushed through? The trillion-dollar one we heard about in June would generate a lot of revenue for American businesses and create a ton of new jobs, which we desperately need right now.
How would economic activity be affected by Biden’s new policies? Perhaps a better question would be how many of these policies could he actually get passed in their current form? Thus far, corporate America does not seem too scared off of them despite potentially losing some of Trump’s more market-friendly policies. Biden is leading in many polls — and yes, maybe we should throw polls out after 2016 — but the stock market is smart and begins to price in all of the possibilities ahead of time. My take is that Biden would need to redirect the increased government tax revenue in a beneficial way — perhaps an infrastructure plan of his own to offset the reduction in corporate profits and some companies potentially shifting their operations overseas while seeking a tax haven.
Sentiment & Market Catalysts
The crazy thing about the current state of the stock market is that this monumental election might not even be the biggest driver of price movement — at least in the near-term. The economy and stock market are currently completely disconnected. They are never one and the same but right now, the stock market at all-time highs really does not reflect our economic numbers.
The market is moving based on liquidity and sentiment. The Federal Reserve provided plenty of liquidity. Now, we need a positive investing sentiment. There are several things that could bring that:
- New stimulus package as the two sides begin to find common ground
- Positive vaccine news approaching their target dates
- Continued real estate and construction booms across the country
- Relief that the election is over and there is a clear path forward
- Note: the S&P 500 went down 4% in 2000 during the Florida recount battle before Gore conceded to Bush
- Post-COVID spending and travel boom — whenever that may be
You probably don’t need a reminder that what politicians say they are going to do and what they actually do is often different. It may not always be their fault because other levels of government would need to approve their plans in most instances. Moreover, things can look quite a bit different by the time they get passed, if at all. And as 2020 has shown us — circumstances can definitely change fast. Buckle up because it is likely to be a volatile few weeks ahead.