As the fall political season heads toward a crescendo between now and December, Democratic Party leaders are seeking to enact a multitrillion-dollar legislative agenda. The big-ticket items at stake include a roughly $1 trillion infrastructure bill and a what will likely be a separate $1.5 to $2 trillion spending plan focused on health care, education, family support and climate change initiatives.
To help pay for these ambitious programs, a series of tax hikes are on the table, including an increase in the top marginal corporate tax rate, which would go from 21% to as high as 26.5%, according to a recent proposal in the House of Representatives. Higher corporate taxes will gain approval, in my view, although I think 25% is more likely to be the final number.
Investors who may be worried about drastically higher taxes or new spending programs should keep one key factor in mind: The outcome will be shaped by centrist Democrats in the Senate. That means a big chunk of what’s created headlines recently will be seriously scaled back, in my opinion, as progressive goals meet the reality of the Democratic Party’s slender majorities in the House and Senate.
Here’s a brief look at the major issues, along with an assessment of the likely outcomes. On the next page, you’ll also see some actions to consider for your year-end financial planning from Capital Group Private Client Services’ tax and estate specialists.
In these highly partisan times, please note that what follows is not a matter of “taking sides” but rather of scanning the policy landscape to assess the implications for investors. As I always say to the investment team at Capital Group, this is analysis, not advocacy.
While one could argue that the Democrats’ original proposal to spend $3.5 trillion over 10 years isn’t all that much compared to the size of the U.S. economy — it’s roughly 1.2% of expected GDP over that period — there simply isn’t enough support in Congress for such a large figure. After all is said and done, as President Biden has acknowledged, the top-line number in the budget reconciliation bill will probably slim down to $1.5 trillion or $2 trillion.
New revenue generated by proposed tax increases probably will amount to about $500 billion to $750 billion over the next decade, with most of the new tax burden falling on corporations. The rest will be deficit funded or wished away via fuzzy economic growth assumptions. Individual income tax hikes will account for a much smaller portion of the revenue pie and focus mostly on high earners. Those making more than $400,000 a year will probably see the top income tax rate rise to 39.6%, and the capital gains tax could climb to 25% or so. A 2% excise tax on stock buybacks is also in the mix and might be seen as a politically feasible way to raise needed revenue.
Over the next month or two, the dilemma that Democrats face is how to shrink $3.5 trillion worth of big ambitions into a smaller package. Major spending priorities will collide, and there remains a chance, given complicated disputes within the Democratic Party, that the entire legislative agenda collapses. Coming up empty-handed would be a political disaster for Democrats as they head toward the 2022 midterm elections, but this scenario can’t be ruled out.
Make no mistake, every move in Washington right now is being carefully calculated with the midterms in mind. While the election is still more than a year away — and that’s a lifetime in politics — history suggests we will see a backlash against the party in power that will result in Republicans taking back control of the House and potentially the Senate.
Democrats are certainly worried about this outcome, which is why they feel the urgent need to pass their ambitious agenda now. Assuming history repeats itself, Republican control of the House or the Senate will end the affirmative phase of Joe Biden’s presidency and the Democratic Party’s lofty legislative ambitions.
Whether you think that’s a good outcome or a bad one, historically speaking, it appears to be the market’s favorite choice. From 1933 to 2020, under unified governments or a unified Congress, the average annual return for the S&P 500 Composite Index has fallen into a broad range from roughly 7% to 10%. When Congress was split, however, the average was 10.8%.