Over the summer, we published a report on the policy and investment implications for different election outcomes. However, given the direction the race is headed, it is important to revisit the implications from the Democratic sweep scenario as that outcome has risen in probability.
Though we initially viewed this outcome as negative for risk assets, the failure of Congress to pass additional fiscal stimulus measures has changed our thinking. Over the longer term, a Democratic sweep will mean higher corporate taxes and higher personal taxes for high earners, but we believe the potential for additional fiscal stimulus and spending will outweigh these negatives and have a short-term positive effect on equities. In addition to stimulus checks and funds for state governments, a Democratic government would likely push for additional spending in areas such as infrastructure as part of a larger-scale bill later in 2021.
Should the Republicans hold the Senate along with a Biden win, our base case is that a Republican Senate has little interest in passing a large spending bill and will greatly limit the size of any stimulus into 2021. After a massive fiscal expansion this year, the U.S. would experience a large-scale fiscal contraction next year.
A Biden presidency would also have some clear negative implications for equities. The first and probably most likely to get enacted is an increase in corporate taxes. Biden has campaigned aggressively and openly on this issue, which plays well with progressives. Though Biden has proposed an increase in the corporate tax rate to 28%, we believe the final number will likely be closer to 25% and phased in over a number of years. Still, in the longer-term this will hurt after-tax earnings for corporations. In tandem with taxing domestic earnings, a Biden administration will probably reform the way foreign earnings are taxed and implement a minimum tax. Should Republicans hold the Senate or President Trump win re-election, we do not expect much change on the tax side other than an extension of the current policy passed by the Trump administration.
On the personal income tax side, the Biden campaign has a number of proposals, all targeting individuals earning $400,000 or more. First, a roll-back of the Trump tax cuts to return the top marginal tax rate to 39.6%. Itemized deductions would also be capped at 28%. Those who qualify for the higher marginal tax would also be exposed to a new 12% Social Security payroll tax. Additionally, capital gains taxes will go up to 39.6% for those making $1,000,000 or more a year. If the election results in a split government, we expect more modest tax changes such as a small increase to the estate tax, while a Republican-controlled Senate and second Trump term may look for ways to cut taxes, such as indexing capital gains taxes to inflation.
Other policy objectives that seem likely to pass through a Democratic government are an expansion in health-insurance subsidies, a large bill to combat climate change, an increase in infrastructure spending and the reduction of prescription drug prices. Passage of such bills would represent an aggressive expansion of the U.S. budget deficit for an administration that will also have to continue the fight against COVID-19 and provide the economy with enough stimulus to avoid a double-dip recession.