Tax Policy Under Biden and Democrats

One of my preferred economists, Brian Wesbury of First Trust Advisors, published an analysis of proposed tax policy and its implications to the economy if enacted. Most of these policies cannot be enacted without Democrats taking control of the House, Senate and White House. The analysis implies that some proposals may not have a significant adverse affect while others will. Without question, these proposals, or other versions, will usher in another round of job killing economic policies of Democrats. Keep in mind that all of this would be on the heals of one of the worst economic calamity ever forced on the economy by Democrats. Here is the analysis.

"What many investors are focused on is a scenario where Biden wins and the Democrats also take the Senate. In that scenario, the Democrats could use the special budget process on Capitol Hill to raise taxes permanently (meaning no natural sunset) with a simple majority, like President Clinton did in 1993.

Biden's team has made plenty of tax proposals, but we're going to focus on what we call the Big Five:

1. Raising the top income tax rate on regular income back to 39.6% from 37% 
2. Raising the corporate tax rate to 28% from 21%
3. Ending the step-up basis at death
4. Treating long-term capital gains and qualified dividends as regular income for those earning over $1 million
5. Applying the Social Security payroll tax on incomes over $400,000+ 

If the Democrats win the Senate, a Biden Administration is likely to be successful at raising the top personal rate and the corporate rate, as well. We think lifting the top income tax rate back to 39.6% would hinder economic growth, but the effect would be small. That's where the rate was under Clinton and in President Obama's second term, and no recession happened in either period.

On raising the corporate rate to 28%, we suggest looking at the glass as half-full. Although we'd prefer the corporate rate to stay at 21%, did anyone seriously believe the corporate rate would stay there forever? The corporate tax rate was stuck at 35% from the early 1990s through 2017 and hadn't been as low as 21% since the 1930s. The market is a discounting machine. If Democrats take back power and only raise it to 28%, that's a win, in a way, because it means future policy debates on the corporate tax rate will range from 21% to 28%, not up to 35%.

President Biden also wants to apply a minimum profits tax of 15% on larger companies' GAAP earnings, but we think this policy would have more bark than bite. The idea is that some companies are using legitimate tax maneuvers, like fully expensing investment, so they show very low (or no) taxable profits even though their GAAP earnings are high (because GAAP has them depreciate investment costs gradually over time). But companies would react by manipulating their books to show weaker GAAP profits, knowing savvy investors would see through the ruse. Companies could also spin off big investment projects to other companies that have large taxable profits, then lease the investment.

Although the Biden Administration would want to raise taxes on capital gains, we think he'd need more than a narrow 51 or 52 seat Senate majority to pass those changes and, even then, would have a tough time eliminating step-up basis at death or treating capital gains and ordinary dividends as regular income for those earning $1 million or more.

Eliminating the step-up basis at death would be an administrative nightmare for some heirs who inherit assets with no records of when the assets were originally bought or at what price. And many of these heirs are far from wealthy themselves. More likely, the Senate would reduce the exemption amounts for the estate tax, instead.

More troublesome from an economic growth perspective would be treating capital gains and qualified dividends as regular income for those making $1 million or more. For dividends, this would unravel about twenty years of tax policy reducing the double-taxation on dividends, because monies are taxed when a company earns profits and then again at the personal level. On long-term capital gains, the tax rate hasn't been as high as 39.6% since the early years of the Carter Administration. That's right, even Jimmy Carter thought that tax rate was too high!

Raising it that high would be a major disincentive for investors. And, given that the economy will be far from fully healed in 2021, we have serious doubts the Biden Administration could rally relatively moderate Democrats to such a tax hike. Remember, President Obama had 59 (and then 60) Senate votes and a large majority in the House, when he became president in 2009. And yet the Bush tax cuts he inherited were not unwound until 2013. And then, only partially.

The most aggressive proposal would be to impose the Social Security tax on regular earnings above $400,000. At present, that tax – 6.2% on workers, 6.2% on employers – applies only on the 'wage base" up to $137,700 in 2020, with the wage base going up each year based on wage growth.

Imposing an extra 12.4% tax would be a large disincentive for high-income workers. Tack that on top of the official 39.6% income tax rate, plus the 2.9% Medicare tax, and we're at more than 50% (our math is factoring-in that some of the cost is paid by the employer, but the cost is ultimately borne by the worker). Then add in a top tax rate of 13.3% for California, which may be going higher, and you have net marginal tax rates nearing 65%."

Source - excerpts: This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.