Back to the future with the Biden tax plan
by Gary Schlossberg, Global Strategist and Michelle Wan, CFA, Investment Strategy Analyst
- The Biden tax plan to raise corporate and individual taxes could increase government spending exceeding the economic “drag” from higher taxes. Potentially far-reaching implications of the plan extend beyond increased revenues.
- Itemized deductions of upper-income taxpayers could suffer a haircut from a 28% cap on such deductions, hitting hardest at high-income, high-tax states.
- Delinking Social Security benefits from Biden’s proposed payroll tax on income above $400,000 could be a first step away from a pension-based system to general-revenue funding and use of the payroll tax as an income redistribution vehicle.
A high-stakes gamble?
The philosophy behind former Vice President Joe Biden’s determination to reverse, if not move beyond, the president’s cornerstone Tax Cuts and Jobs Act of 2017 is two-fold. First, it would seek to remedy income inequality through revenue-raising proposals skewed toward upper-income taxes. Second, it would aim to boost revenues to finance new and expanded government-spending programs capable of lifting the economy from the deep hole dug by the pandemic. At issue is whether the Biden tax plan will outweigh the spending stimulus centered on infrastructure, telecommunications, research and development, and government procurement of supplies that are essential for national security. Table 1 provides highlights of the Biden tax plan, compared to current law and rules in place before the 2017 tax reform.
Table 1. Comparing the Biden tax proposal with current law and pre-2017 rules
Missing from the Biden tax proposals are such progressive favorites as wealth and financial-transaction taxes. The plan also retains Biden’s top 39.6% individual income tax rate, rather than going the extra mile with Senator Bernie Sanders’ 52% proposed top marginal rate. Still, seemingly moderate Biden proposals could have a far-reaching effect on Social Security, investment, and (more generally) entrepreneurship, innovation, and incentives to put in extra hours of work. Biden’s tax framework may provide needed financing for spending programs designed to revitalize the economy. However, calculating the right balance between each of two key issues in the campaign—first, higher spending and taxes to boost growth—and second, the mix of spending and tax hikes needed to gain sufficient support from the party’s progressive wing and independent moderates likely will be needed to win the election.
More than just an election-year tax increase
The consequences of Biden’s proposed tax changes could extend beyond the increases themselves. For starters, a Social Security payroll tax on income above $400,000 not accompanied by increased benefits could suggest a first step in moving from a strict pension-based system to general-revenue funding as a means of improving income distribution. A second concern is that higher payroll and other business taxes could lift marginal federal and state taxes enough to discourage business formation, jobs, and growth-supporting innovation.
Third, the proposed 28% cap on itemized deductions would hit hardest at taxpayers in high-tax, high income, states—offsetting some of the taxpayer savings if the $10,000 cap on state and local tax deductions is raised or rescinded in separate legislation. And fourth, higher corporate tax rates, including the proposed 28% statutory rate (versus a global average below 22%), could encourage renewed efforts by U.S. firms to relocate to lower-tax countries when they merge with foreign firms—or reduce U.S. competitiveness by leaving higher-taxed U.S. firms at a disadvantage in matching earnings growth abroad. As it is, our estimates show that higher U.S. corporate income taxes would lower S&P 500 earnings per share by an estimated 5%-6% annually after implementation.
Enacting the kind of tax changes proposed by the former vice president may be difficult, even with single-party control by Democrats of the White House and leadership in both congressional chambers. As recently as 2017, the Republicans gained control of the government but quickly became bogged down over policy priorities and specifics. Nevertheless, a change to “one-party control” by the Democrats may eventually eliminate many of the tax strategies currently available to high-net-worth individuals, perhaps even retroactively to January 1, 2021. We favor consulting with financial advisors and wealth planning teams, together with tax and legal counsel, for assistance with potential planning opportunities before year-end 2020.
“Green” gold? Biden’s plan for a green America
by Paul Christopher, CFA, Head of Global Market Strategy and Tony Miano, Investment Analyst
- It seems unlikely that the U.S. will be able to replace the fossil-fuel industry in its entirety. We would expect renewables to gain more market share, but with fossil fuels remaining as the backbone of U.S. energy production and usage.
- Even if there were a split government, Biden (as president) likely will be able to implement portions of his clean energy plan through bipartisan agreement for less contentious issues and executive orders for others.
- Technological advancements in batteries are required for renewables to truly replace fossil fuels. Energy storage issues likely will hamstring any serious change until that point.
Outline for the future
As part of his “Build Back Better” economic plan, Biden has unveiled a sweeping proposal to promote clean energy production and address climate change. These proposed changes take aim at almost every part of the American economy, with specific attention given to the auto and electricity production industries, clean energy research and development (R&D), and infrastructure. Some of these proposals, like extending renewable energy tax credits, are fairly simple. Others, like the proposal’s primary goal of achieving net-zero emissions economy-wide by 2050, likely will prove to be more trying.
In its current state, the plan is expected to have a price tag of roughly $2 trillion over four years.1 It’s likely that the majority of this cost will be funded by taxes on corporations and high-income earners, which Biden already has announced—but it’s entirely possible that this proposal may be framed as a form of economic stimulus. In 2019, renewable energy made up roughly 11% of energy production in the U.S.2 This means that there is a significant amount of investment required in the renewable energy industry if Biden aims to meet his goals.
A question of efficiency
Potential obstacles in the path to implementing Biden’s clean-energy policies are numerous and varied. Biden’s full policy likely would require the Democrats to have a strong leadership grasp on both the House of Representatives and the Senate—a goal which is by no means a guarantee. Some states derive significant tax revenue from fossil fuels.3 While environmental and renewable energy taxes have the potential to recover this revenue, we believe that politicians on both sides of the aisle will oppose any direct challenges to the fossil fuel industry. More incremental changes, such as increased conservation efforts or clean energy R&D, seem much more likely, regardless of which party controls the Senate. A President Biden could use executive orders to circumvent congressional inaction, but we believe that they also would be inadequate for total implementation of Biden’s clean-energy proposal. For example, orders to tighten emissions and fuel efficiency standards are likely but should fall short of Biden’s grander plans.
Even if implementation of Biden’s clean-energy proposal were a sure thing, questions about the practicality remain. Chart 1 demonstrates the small part that renewable energy has played historically in U.S. energy production. While the market share of renewable energy has grown significantly in the past 30 years from 8.6% to 11.5%, the growth rate would have to be exponentially higher to meet Biden’s target for the next 30 years.4 All forms of renewable energy combined still produced less energy in 2019 than coal, a fossil fuel which has seen its prevalence in the U.S. energy industry plummet in the face of increasing environmental regulations.
Chart 1. U.S. renewable energy—share of total energy production
In their current state, renewables suffer significantly from issues surrounding ease of storage. While it’s easy to store a barrel of oil or ship it to another country, doing so with energy from renewables, essentially in the form of giant batteries, is much less efficient. Since energy needs are constantly shifting, and no one can make the sun shine brighter or the wind blow harder to pick up production, renewables will require storage technology significantly beyond our current means. Most countries are either energy exporters or energy importers, which means that safe, efficient storage and transportation of renewable energy is essential if it is to replace fossil fuels.
Due to the significant issues surrounding Biden’s clean-energy proposal, we do not believe that it will be able to meet its long-term goals in any meaningful capacity—barring any breakthroughs in battery technology. We would expect Biden to implement the more moderate portions of his proposal but to fall short of any significant impact to the fossil fuel industry as a whole. The effect on fossil fuel production in the U.S. seems likely to be constrained to less popular and more environmentally damaging areas as has happened to coal in the past. We expect natural gas to continue to make up the majority of U.S. energy production, while increasing efficiency standards and renewable energy make impacts at the margins.
Biden’s “Buy American” pitch
by Michael Taylor, CFA, Investment Strategy Analyst
- Last month, former Vice President Joe Biden unveiled details of his “Buy American” platform. The proposed economic policies aim to revitalize U.S. manufacturing and offer a counter to President Trump’s “America First” platform.
- Biden pledges to create five million high-quality jobs in manufacturing and innovation. His plan would tighten restrictions on U.S.-made goods and increase government procurement of them.
- The “Buy American” plan does not alter our unfavorable outlook on the Industrials sector; nor does it outweigh the other reasons why we are comparatively more favorable on other U.S. equity sectors.
The pandemic has disrupted the U.S. economy, stifling U.S. workers and businesses. Moreover, massive layoffs and persistent unemployment have exacerbated the strain on U.S.-China relations, by calling into question the offshoring of American manufacturers in recent decades. President Trump has pledged to return offshore firms to the U.S. and revitalize American manufacturing since his 2016 campaign; Democratic presidential nominee Biden now appears poised to follow suit. His “Buy American” plan purports to create jobs, rebuild U.S. manufacturing, and invest in innovation.
This may be an effective posture for Biden to take as China has now become a bipartisan issue. A recent Pew Research Center poll revealed that 73% of Americans currently hold an unfavorable view on China, up 26 percentage points since 2018—and that sentiment appears split down party lines.5 In a similar poll, although Biden garnered more confidence around issues like handling race relations and the coronavirus’ public health impact, Trump outperformed on economic policy. This suggests that Biden may have some work to do to persuade undecided voters, particularly since the economy typically is a key issue for voters. Biden and the Democratic Party are keen on developing strong economic policies that resonate with voters, particularly in the Mid-Atlantic and Rust Belt swing states which Trump won by a thin margin in 2016. Below, we review key components of Biden’s “Buy American” plan.
Made in all of America, by all of America’s workers
In July, Biden unveiled details of his “Buy American” platform. The proposed economic policies are part of his broader “Build Back Better” agenda and counter President Trump’s “America First” platform.6 Biden’s U.S.-focused economic policy proposal comprises six components that aim to bolster the U.S. manufacturing base:7
- Buy American: Make buy American real and make a $400 billion procurement investment during the next presidential term.
- Make it in America: Retool and revitalize American manufacturers.
- Innovate in America: Make a new $300 billion investment in R&D and breakthrough technologies.
- Invest in America: Ensure that investments reach all of America by drawing on the full talent of workers and investing in the potential of all communities and workers.
- Stand up for America: Pursue a pro-American worker and tax and trade strategy.
- Supply America: Bring back critical supply chains to America.
Biden has pledged to create five million high-quality jobs in manufacturing and innovation. His plan would tighten restrictions on what qualifies as U.S.-made goods and increase government procurement. The plan emphasizes clean energy and infrastructure, and it aspires to boost U.S. production of medical supplies, pharmaceuticals, and personal protective equipment (PPE). This follows shortages during the pandemic, reflecting how dependent the U.S. health-care supply chain has become on China.
Biden maintains that these spending proposals would be offset by a revised tax plan to raise corporate and individual income taxes, partially reversing a portion of the Trump tax cuts. The corporate rate would rise from 21% to 28%, and individuals with incomes above $400,000 would see income-tax rates rise from 37% to 39.6%. Yet, some of these tax increases could be offset by abolishing Trump’s trade policies or lifting tariffs on imports.8
What does “Buy American” mean for the economy and investors?
Historically, the economy’s strength has been a key indicator for an incumbent president’s election success. In January, Americans were largely positive about economic conditions, yet polls also indicated that the economy was an “extremely important” or “very important” election issue for voters.9 In April, only 13% cited economic problems as the top concern facing the U.S.; that number eased to 9% by July.10 Although this is a relatively low ranking compared to past elections, other more pressing issues were cited: coronavirus, poor government leadership, and race relations. Voters seem dissatisfied with elected officials’ handling of the pandemic, which surely has economic repercussions. Further, since January, Trump’s approval rating on the economy has slid from 63% to 47%, suggesting that Americans may be growing disappointed with his handling of the economy.11
Although “Buy American” targets economic improvement, it is not clear how the program will improve either the public’s (or our) manufacturing outlook. The proposal to spend $700 billion over 4 years ($175 billion per year) is small—less than 8% of the value of 2018 U.S. manufacturing output.12 We believe the economic recovery is a much more important factor; it is one that leads us to favor U.S. large caps and mid caps for their efficiency (low cost structures) and their generally strong balance sheets. This is most true for sectors we favor—including Information Technology, Communication Services, Consumer Discretionary, and Health Care. We remain unfavorable on Industrials, because their revenue is global, but global trade remains weak. These same negatives for Industrials have undercut President Trump’s promises to revive U.S. manufacturing. We have not seen a federal policy initiative yet that tilts our outlook more favorably to the Industrials sector.
1 “Washington Note: Race to 2020 Series—Biden’s Climate Change Plan”, Credit Suisse LLC, July 22, 2020.
2 “Monthly Energy Review”, U.S. Energy Information Administration, July 28, 2020.
3 “The Challenge of State Reliance on Revenue from Fossil Fuel Production”, The Brookings Institution, Adele Morris, August 9, 2016.
4 Including Texas, Oklahoma, Ohio, and Pennsylvania, among other states, amounting to significant political sway in Congress. See “Monthly Energy Review”, U.S. Energy Information Administration, July 28, 2020.
5 Pew Research Center, July 30, 2020.
6 See www.Joebiden.com for details of these plans.
8 See our report titled “Election Q&A: What if the Democrats Sweep in November?”, July 28, 2020, for more details.
9 Gallup, January 13, 2020.
10 Gallup, June 29, 2020.
12 “2019 United States Manufacturing Facts”, National Association of Manufacturers.
Forecasts and targets are based on certain assumptions and on views of market and economic conditions which are subject to change.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks.
Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market.
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