Dems took the first swing; now the GOP gets its chance.
Bottom Line Democrats wrapped up their unconventional convention last night, with former Vice President Joe Biden accepting the nomination for president. The week resembled a series of giant Zoom meetings, with a mix of live events and recorded speeches from participants scattered across the country. While the remote confab lacked the typical engagement and energy—no balloons, confetti or funny hats—Democrats made the right decision to cancel their convention in Milwaukee due to the coronavirus. Network ratings were down an estimated 25-30% from 2016, but that likely was more than offset by increased streaming and online viewership.
The Democrats’ focus was to hammer home what they believe to be President Trump’s lack of fundamental fitness for the presidency, and to focus on Biden’s strength of character. The Republicans get their turn next week, and they are expected to focus on Biden’s possible fiscal policy agenda and its potential impact on economic and corporate profit growth, the labor market, inflation and financial-market performance. Ultimately, this trade-off between the character of the two candidates and the efficacy of their sharply different fiscal policy platforms will decide what we believe will be a close, contentious election on Nov. 3.
Character counts The Democrats this past week orchestrated a gavel-to-gavel character assassination of President Trump, as speaker after speaker reiterated similar unflattering themes: he is in over his head, lacks empathy, and that he is incompetent, self-centered, self-interested, racist and misogynist, among other ugly charges.
Biden, they argued, is the anti-Trump—an honest, caring, principled and empathetic family man. He’s a political moderate who knows how to reach across the aisle to get a mutually beneficial deal done.
In his acceptance speech last night, which Andrea Mitchell of NBC News characterized as the best of his career, Biden said that this is a life-changing election, with character, compassion, science and democracy all on the ballot. He identified four challenges on which he would focus his presidency: the pandemic, the economic recession, racial justice and climate change.
To be sure, Biden was light on details last night, and he certainly will need to flesh out his agenda during the debates with Trump in September and October. We believe the focus of the GOP’s hybrid convention in Charlotte, N.C., starting Monday, will be to discredit Biden’s economic plans, which likely include the following:
Increase corporate tax rates In 2016, the combined U.S. corporate tax rate stood at 39%, compared with a 22% average for OECD countries. Economic growth here was tepid, and that spawned an inversion problem, with U.S. companies domiciling into foreign countries like Ireland (12% tax rate), moving jobs, intellectual property and manufacturing plants offshore to boost corporate profit growth. In addition, about $2.5 trillion of corporate cash was stuck on overseas balance sheets, not coming home at a 39% tax rate.
Trump cut the corporate tax rate to 21%, which resolved the inversion problem, and he instituted a lower repatriation rate. As a result, nearly $1.4 trillion of cash has returned to the U.S., sparking increased capital spending here and the strongest labor market in half a century. Unemployment stood at only 3.5% in February before the pandemic hit U.S. shores. If Biden raises corporate tax rates from 21% to 28%, as he has proposed, it likely will reduce corporate profits, harm job growth, reintroduce inversion, reduce corporate investment and lock corporate cash overseas.
Raise individual tax rates Biden is proposing to restore the top bracket at 39.6%, tax capital gains and dividends as ordinary income (at 20% and 22%, respectively, now) and not fully restore the state and local tax (SALT) deductions by capping them at 28% overall. This likely will reduce consumer spending and risk taking and inhibit real estate investing, which will reduce economic growth, job creation and financial-market performance. Biden talks about people paying their “fair share.” But according to 2017 IRS data (which is the latest available), the top 1% of Americans earn 21% of total income in the U.S. and pay 39% of the taxes; the top 10% earns 48% of the income but pays 70% of the taxes; and the bottom 50% earns 11% of the income but pays only 3% of the taxes. So it appears as if the tax code is already very progressive. How much more progressive should we make it, and how damaging will the impact be on the domestic economy?
Eliminate the cap on Social Security wages At $137,700, eliminating this annual wage cap could have a sizably negative impact on the top 10% of America, resulting in a 12.2% tax increase, half of which is paid by employers. This might result in less business and consumer spending, slower wage growth and less hiring.
Increase estate taxes Biden plans to raise the tax rate from 40% to a graduated rate of 77%, reduce the exemption from $11.58 million currently to $3.5 million and eliminate the step-up basis on estate taxes. This could pressure liquidity among small businesses and family farms, which could harm employment.
Double the Federal minimum wage We have argued extensively over the years that, at $7.50 per hour, the minimum wage is too low because Congress stopped indexing it for inflation in May 2007. Had lawmakers continued to make annual adjustments, it would approximate $10.75 today. But the problem we have is with the pace of correction. Broadly defined, labor costs (including benefits) can account for as much as 70% of a company’s total cost of sales. Increasing the minimum wage will have a domino effect on a company’s overall labor costs because nearly everyone’s wages will need to be adjusted upward. So how will companies adjust? They might pass on higher labor costs to customers in the form of higher prices, which might sharply boost inflation. If the company is in a competitive industry and fears a loss of market share, it might try to absorb the higher labor costs internally, which will eat into their profit margins and reduce (or eliminate) corporate earnings. Alternatively, the business could attempt to increase productivity instead, and replace some of their higher-cost employees with more technology, which could increase unemployment. None of these options are palatable, in our view, so a more intelligent course of action would be to gradually increase the hourly wage up to, say, $12 per hour over the next five years, and then reinstitute annual indexation from there.
Impact on the financial markets Biden's potential fiscal policies could reduce corporate earnings by 10-15% annually. The expected increase in inflation could shrink price/earnings multiples about 10% (from a target of 20 times earnings to an estimated 18). Our back-of-the-envelope analysis suggests stock prices could decline 20-25% if all of Biden’s likely policies are implemented. That’s a big “if,” of course, because there’s plenty of track left between now and Nov. 3. Also, we don’t know if Biden will craft his proposals as we’ve articulated them, and whether Congress would pass them as proposed. In addition, we don’t know if Biden would make any other proposals that might counterbalance the potential negative developments. That’s why we hold elections, and elections have consequences.