What the New Presidency Signifies for Your Money
by Cathy Pareto, MBA, CFP®, AIF® – November 2008
With the election just one day away, we thought we’d spend some time discussing the impact of Presidential politics on your money (or, what’s left of it). It is quite the understatement to say that Tuesday’s winner will be inheriting quite the serious mess. Let’s see, we’re fighting two wars, our economy is in the toilet, we’re in debt up to our eyeballs and our financial markets are in turmoil. Why anyone in their right might would want to be President right now is beyond me. I think I’ll stick to my almost equally-as-stressful job of managing people’s money in the worst financial crisis of our lifetime! But, all kidding aside, make no mistake, the upcoming election has large economic implications, not just for you but for the nation. Let’s assess the situation, and let me add that this is intended to be a non-partisan piece.
The economy is in recession. By definition, two straight quarters of negative growth translates into recession, so the economy is officially half-way there, especially considering fourth quarter data is shaping up to be just as depressing. Home prices are likely to continue to slide. Over one million jobs have been lost in the last 12 months. The recent announcement of third quarter GDP confirmed that the economy actually contracted by 0.3% during the period, the worst results in seven years. Consumer spending accounts for three-quarters of the growth of the economy, as measured by the GDP and the most recent report revealed that spending plunged by 3.1% during the quarter (the biggest pullback since 1980). The stock market crash has reduced global wealth by over $16 trillion dollars, with much of that money held in retirement accounts. So, with all of these negative facts established who might arise as the best man for the job?
Are the elephants or the donkeys better for the markets? The conventional wisdom suggests that a Republican leader fares better for the markets than a Democrat. But, there is really little evidence to support this claim (the Clinton years are a testament to this). Using data from 1926 to August 2008, the S&P500-stock index has done distinctly better under Democratic presidents (9.2% annually after inflation) than under Republicans (4.6%). A recent Wall Street Journal article cited, “While large stocks fared well in Democratic administrations, small stocks have skyrocketed, returning 16.5% a year after inflation, versus just 2.2% annually under Republicans. On the other hand, bonds have done much better in Republican than Democratic administrations (4.8% versus negative 0.4% annually, after inflation).”
Much to the chagrin of either McCain or Obama supporters, party affiliation has very little to do with stock market successes or failures. Instead, the market’s influence in either direction stems more from federal influence like Fed policy and monetary decisions. Specifically, in years when the Fed tightens the money supply by raising interest rates, the market does poorly; when the Fed eases the money supply by cutting rates, the market does well.
Another theory suggests that gridlock in government is also good for the markets. In other words, a filibuster proof Congress and a President from the same party. While I certainly embrace the concept of checks and balances (as any of us might), this too is false given the fact that since 1926 the S&P 500 has gained an inflation adjusted average of 6.3%, whenever one party controlled the White House and the other held the majority in both houses of Congress, compared to 6.8% annual average for the period as a whole.
The reality is, when the stock market is as beaten down as it is right now, it almost has nowhere to go but up in the next four years. So, no matter who might be in office come next January, the winner is surely going to take credit for the inevitable upswing in the market, no matter if he had little to do with the market rally. The environment is ripe for an eventual rally: low interest rates, federal funds rate at 1%, federal bailout policies will be trickling through the economy and banks will start lending again. Although it’s anyone’s guess if we have officially reached a “bottom”.
But, the markets are really only one facet (albeit an important one) of the U.S. economy. The fact it is, the budget deficit is perhaps the biggest challenge awaiting either winner when he steps into the Oval Office. Either candidate will face a budget deficit of around $500 billion when he’s sworn into office — a shortfall expected to climb to $1 trillion next year. So, how do we pay for all this? All roads lead to….
Both presidential candidates have proposed major changes to the nation’s tax laws that would reduce federal revenues and shift in markedly different ways the burden of taxes among households. It is hard to fathom the thought that either McCain’s or Obama’s tax cuts (regardless of whether they are extended to the middle class or the mass affluent) and Obama’s social spending plans will see the light of day in an economy that is at best, on the brink of collapse. The only way to finance this changes are to scrap spending or levy the citizens.
Think about it–reduced consumer spending will inevitably reduce corporate profits, which in turn reduce corporate tax revenues. If corporations are paying fewer taxes, the government has to make up the revenues from somewhere. After the spending spree and subsequent mountain of debt the current administration and (previous and current—Dems and Republicans alike) Congress piled up (shame on them!), this scenario seems almost unavoidable. Somebody’s got to pay for all this, after all, we cannot just keep writing IOU’s to the Chinese!
As it is, the federal government takes about one-fifth of all national income each year (that’s an average). According to the Congressional Budget Office, if you’re in the middle of the income distribution — the middle 20 percent of all households — you pay 14% of your income to the government through taxes and carry (along with other middle income taxpayers) roughly 9% of the federal tax burden. But, if you are in the top 20% of all households, measured by income (earning $100k or more) whose federal tax rate meets or exceeds 25%, you and other high earners like you carry nearly 70% of the entire federal tax burden.
The Democratic candidate has proposed tax hikes for upper-income people (those making $250k or more), not just in federal taxes but social security taxes as well. Tax cuts would follow for the “poorest” Americans. Conversely, the Republican McCain endorses a tax cut for upper income people, but he’d surely have an enormous obstacle trying to pass that bill with a (very probable) Democratic controlled Congress. Not sure where exactly he stands on higher social security taxes, but based on a recent question regarding this issue he could lift the wage cap on the Social Security tax, currently set at $102,000.
Some other key points :
•Estate tax: would exempt the first $3.5 million of an estate and keep the existing 45% tax rate
•Tax rates: proposes to raise rates for upper-income people by going back to the 36 percent and 39.6 percent rates imposed on those folks during the Clinton era (later reduced by Bush)
•Investments: seeks to increase taxes on dividends and capital gains for higher income taxpayers (the ones that do most of the investing)
•Estate tax: wants to cut the estate tax rate from 45% to 15% and make the first $5 million of an estate tax-exempt
•Tax rates: would like to permanently extend the 2001 and 2003 income tax rate cuts introduced by Bush.
•Investments: wants to keep existing rates on dividends and capital gains, or even lower them
For a more detailed comparison of the candidates tax plans, click here.
In closing, tax and fiscal policy will play a pivotal role in the next president’s domestic policy agenda. Nearly all of the tax cuts enacted since 2001 are set to expire at the end of 2010 and the individual alternative minimum tax threatens to trap tens of millions of Americans in its complex web, including middle income Americans. Both candidates are expected to extend their federal intervention for the weakened economy and broken financial system, so there is no doubt that the health of the economy will influence the tax debate as the new president takes his place in history. One might argue that the markets have already priced what appears to be a likely Democratic victory. Although, it’s anyone’s guess how things really turn out if election year 2000 is any indication. We can rest assured that whomever takes office in January, Republican or Democrat, the fate of our country, the financial stability of its citizens and America’s ability to extend its leadership in the world will lie squarely on the next administration’s ability to craft appropriate solutions. Let’s hope the next four or eight years yield better success than the last eight, for all our sakes.
1 Ibbotson Associates, Chicago
2 Wall Street Journal, Jason Zweig “If You Bet on the Election, Don’t Use Real Money” September 6, 2008.
3 Wall Street Journal, Jason Zweig “If You Bet on the Election, Don’t Use Real Money” September 6, 2008.
4 Tax Policy Center Library, “A Preliminary Analysis of the 2008 Presidential Candidates Tax Plans”.