Big Government is Back

3/24/2021: Market Update by Jack Ablin, Chief Investment Officer at Cresset

The Biden administration has passed a massive $1.9 trillion stimulus program designed to get checks into the hands of low-income Americans. This program represents the liberal policy shift in politics and economics that gained traction during the coronavirus pandemic. It also signals a more prominent role for government in attempting to solve society’s problems and inequities, and it could catalyze future legislation on the scale of FDR’s New Deal or Lyndon Johnson’s Great Society. Current policy initiatives appear intended to reverse many of the supply-side trends that were set in motion under the Reagan administration. The strategy ushered in decades of deregulation, low taxes, limited government and free markets. President Trump’s corporate tax reform in 2018 was designed to generate job growth by incentivizing employers. Trickle-down economics worked well for income growth, but it worked even better for capital accumulation.

Our collective experience last year laid bare the impact of government policies on the governed. Inequality in education, employment, politics and health took center stage at the height of our manifold challenges. Pre-pandemic, college graduates in the US earned 80 per cent more than their undereducated counterparts. For years, US adult life expectancy had been falling for non-graduates while rising for graduates. The pandemic deepened the chasm: college graduates were more likely to be able to work from home, protecting their incomes and health. In the US, amidst the pandemic, the poorest 20 per cent of the population suffered 80 per cent of the lockdown-induced job losses.  Meanwhile, rising stock markets favored the wealthiest households who own the greatest share of financial assets.

Last year’s lockdowns, mask mandates and social distancing tested America’s doctrine of putting the individual before the collective. Proper public health policies subjugate the individual to the collective, and last years’ experience proved America’s public health needs reform. During the pandemic, many of those who lost their jobs also lost their health insurance coverage. Moreover, escalating health care costs have crowded out wage gains, robbing America’s workforce of good-paying jobs in favor of part-time and contract work or gig jobs.

Both the Democrat and Republican parties face an undercurrent of dissatisfaction among their constituents. Working-class Americans, both red and blue, left behind by education, outsourcing and technology, are frustrated and angry. Wage growth has barely kept pace with inflation over the years.  Their anger may augur a more activist government, armed with checks, tax benefits and other incentives.

President Reagan famously stated that the most terrifying words in the English language are “I’m from the government and I’m here to help.” He also famously stated: “Here we go again.” President Biden’s $1.9 trillion relief package aims to provide a safety net to low- and middle-income households to enable them to make it to the end of the crisis without suffering lasting economic damage. Key features of the bill include $1,400 checks to individuals earning up to $75,000/year, federal jobless benefits through early September and an increase in the child tax credit. The package is expected to deliver the strongest annual economic growth since the early 1980s. The plan was broadly supported by 70 per cent of American adults, including 41 per cent of Republican voters, according to Pew Research. Interestingly, only 9 per cent of the spending package deals directly with COVID-related relief, suggesting that people who broadly agree with the program probably have little idea what is in the package.

Next on the legislative agenda is infrastructure. During the 2020 campaign candidate Biden unveiled “Build Back Better,” a $3 trillion proposal which includes federal investment in infrastructure and dealing with climate change, partially funded by higher taxes on wealthy Americans and corporations. The Biden administration is mulling over such a program as well as the possibility of extending certain aid provisions, like higher child tax credits and jobless benefits. If you squint, these measures could pave the way for Universal Basic Income, in which every American adult receives a set amount of money on a regular basis to alleviate poverty and replace other need-based social programs.

The President also plans to unveil the first major federal tax hike since 1993 which, in the words of a former Biden economic aide, would “[address] the unequal treatment between work and wealth.” Some of the measures under consideration include raising the corporate tax rate to 28 per cent from 21 per cent, paring back the tax benefits of pass-through businesses like limited-liability companies and partnerships, raising the personal income tax rate on individuals earning $400,000 or more and boosting the capital gains tax rate for individuals earning at least $1 million. A study by the Tax Policy Center estimates these measures would raise $2.1 trillion over a decade. If passed, these measures would likely take effect in 2022. The estate tax is another area under review.  Twenty years ago, the estate tax exemption was $675,000 and the tax rate was 55 per cent; since then, the exemption grew while the rate steadily declined. Now, the estate tax exemption is $11.7 million per person with a 40 per cent tax above that amount.

After a decade of bailouts, stimulus programs and massive monetary creation through quantitative easing, the prospect of gaping budget deficits is no longer grist for legislator arm flapping. While fiscal hawks populate the media, academia and the financial industry, they don’t seem to exist in Congress.  Trillion-dollar budget deficits simply don’t move the needle anymore. Economists and lawmakers have grown increasingly sanguine about barrels of red ink over the last decade since, so far, they have not led to economic disaster. Moreover, market discipline has been defanged. Previously, bond investors have kept government profligacy in check by ratcheting up borrowing costs. Now, Federal Reserve bond buying, which is currently $120 billion/month, has undercut bond market blowback.

Faced with the likelihood of higher tax rates next year, it may make sense to consider paying taxes this year, particularly if you were planning to incur the tax eventually. Since the possibility of higher tax rates is a risk, consider diversifying tax obligations, like maintaining a taxable bucket and a tax-free bucket, to provide some options in drawing income in the future. Another strategy for high-income earners is a back-door Roth conversion: contributing into a traditional IRA and simultaneously withdrawing it, paying the tax, and depositing it into a Roth IRA. With the markets near all-time highs, wholesale IRA to Roth conversions seems like a costly strategy; an incremental approach makes more sense.

It’s still too early to tell whether a repudiation of Reagan’s supply-side policies is taking hold. That said, politically savvy lawmakers understand that the imbalance in income and wealth favors policies that benefit the majority at the expense of the wealthy minority. French aristocrat, diplomat, political scientist and political philosopher Alexis de Tocqueville, who traveled the United States nearly 270 years ago, astutely concluded that “the American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.”

PagnatoKarp | Cresset

Specializing in Intelligent Wealth Management™ for CEO Founders, entrepreneurs, wealth creators, and high-net-worth families. With True Fiduciary® standards of Transparency®, your interests come first with a focus on asset protection, cash flow, and open access. Our Family Office goal is to simplify and elevate your life so you have more time to spend on what matters to you most.

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