Biden Would Smother the Economy by Raising Taxes
Promising to make corporations and the well-off pay more may be smart politics but it’s shortsighted policy.
By Michael R. Strain - October 14, 2020, 7:00 AM PDT
A high priority for a Biden White House would be to raise taxes on high-income Americans, and to push the corporate rate up to 28% from 21%. This would satisfy many progressives who want to see higher taxes at the top, but it would be a wrong-headed policy for a new administration, creating a headwind in a weak economy. And increasing the corporate rate would reduce U.S. competitiveness, productivity and wages over the longer term.
Biden pledges not to increase individual taxes on “anyone making less than $400,000.” The top individual income rate would go back up to 39.6%, from 37%, among other provisions. All told, the Biden plan would generate around $4 trillion in revenue over the next decade, a considerable amount.
But the economy will be in bad shape throughout 2021, with unemployment still high and output considerably below its pre-pandemic level. Colder weather in winter will limit outdoor dining, and a resurgence of the virus in Europe will likely dampen U.S. exports. With Covid-19 still spreading, people will continue to curb their activity — and a strong resurgence of the virus would threaten to move the recovery backward. Even the most optimistic analysts expect that much of the year will pass without a vaccine in wide distribution.
In this macroeconomic environment in 2021, the White House should be leading an all-hands-on-deck effort to get the economy back on track by supporting households, businesses, and state and local governments before the arrival of a vaccine. If elected, a Biden White House would only have so much political capital. Tax increases would slow growth or leave it relatively unchanged. Why use any capital on policies that won’t speed up the recovery?
Of course, the Biden plan as a whole would increase spending as well as taxes. Conventional economic scoring suggests that a Democratic sweep in November would lead to stronger economic performance than if Trump were re-elected and Republicans kept the Senate. Moody’s Analytics, for example, forecasts GDP to grow 4.2% in 2021 and 7.7% in 2022 if Biden wins and Democrats take the Senate. Moody’s forecasts 2.3% and 4.5% growth in 2021 and 2022, respectively, under the political status quo.
What’s driving the difference? It isn’t Biden’s proposed tax increases. Instead, Moody’s assumes that Biden would enact his full economic agenda — an additional $7.3 trillion spent on infrastructure, education, the safety net, Social Security, housing and health care, by their tally. Because all this spending is largely deficit financed, it juices growth in conventional economic models, overwhelming any drag from the proposed tax increases.
Moody’s estimates Biden’s plan would increase the deficit by $2.6 trillion during his first term, after taking both proposed spending and tax increases into account.
Even after the economy is back to full health, a President Biden shouldn’t raise the corporate tax rate. If he did, companies would respond by investing less in factories and equipment in the U.S. Less investment means workers are less productive, which reduces their value to companies, lowering their wages.
In the debate over the 2017 corporate rate reduction, supporters and opponents alike got this story wrong. Supporters of the cut raised expectations that workers’ wages would immediately increase. Yet it takes time for lower taxes to improve investment, productivity and wages. Opponents pointed to the fact that many companies returned funds to shareholders following the tax cuts, rather than using the savings to boost investment. But the use of the immediate tax savings was beside the point. What mattered was how the new tax incentives affected future behavior.
In today’s political climate, the argument that higher corporate taxes would reduce wages may sound like a right-wing talking point. Instead, it is the standard view among economists. The nonpartisan Congressional Budget Office argues that workers bear 25% of the burden of the corporate income tax. The Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution, concludes wages and labor income bear 20% of the burden of the corporate tax.
None of this is to say that the U.S. doesn’t need additional tax revenue. Even without the additional spending on Biden’s agenda, the U.S. government needs a higher tax burden in order to put the national debt on a downward trajectory. The CBO projects that next year, for the first time since World War II, the national debt will be larger than annual economic output. In 2023, the budget office forecasts that the debt will be larger than at any point in U.S. history.
The growing cost of Social Security and federal health programs, including Medicare, are driving these projections. While spending cuts should make up the lion’s share of efforts to address the national debt, relying only on reductions in Social Security and Medicare is neither politically feasible nor desirable. Tax revenue will have to increase, as well.
The massive borrowing that has taken place to finance economic recovery programs in the pandemic was wholly justified. But in a healthy economy, additional spending should be paid for. Biden is right to pair his proposed spending increases with more tax revenue.
Some of Biden’s proposed tax increases would be a sensible way to raise revenue — if enacted after the economy recovers. For example, he would eliminate tax preferences for certain favored industries, including real estate and energy companies. But if a Biden administration wants to address the structural budget deficit or pay for new spending programs, it should look to new sources of tax revenue other than income.
Econ 101: If you tax something, you get less of it. So let’s tax something we want less of, like pollution. Income taxes mean less income, which means less work, saving and investment. So let’s tax consumption rather than income.
In a weak economy with a once-in-a-century pathogen slowing economic activity, we don’t want less income, so Biden’s plan to raise income taxes is misguided. And even in a strong economy, the U.S. should not increase corporate taxes.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg
FULL RECOVERY REQUIRES REOPENING
First Trust Economics - September 28, 2020
With the presidential election just over a month away, prospects for another round of fiscal stimulus seem to be dwindling. The recent death of Justice Ginsburg and the rapidly approaching election have shifted the Senate’s gaze.
Conventional wisdom is worried that a lack of additional stimulus, and the potential for a drawn out and contested election, could impede the economic recovery. And some of those fears seem to be reflected in the stock market recently, with the S&P 500 having fallen 7.9% from its high of 3588 on September 2, as of Friday’s close.
While we need to wait for August data on incomes, through July, the Commerce Department’s measure of personal income was 4.9% higher than in February, as government transfer payments - which the US borrowed from future taxes - more than fully offset declines in wages and salaries. Think about that for a moment. Even with the end of special unemployment bonus payments, there is likely more money in people’s pockets today than there would have been had the pandemic never happened!
Right now, any weakness in the economy is coming from the fact that many sectors (especially service-type activities) remain shut down or lightly used. Spending on goods in July was up 6.1% from February, while spending on the more pandemic-restricted service sector was down 9.3% over the same period. Overall spending (goods plus services) remains down 4.6%. We doubt a full recovery can happen without a rebound in services.
Additional checks can’t change Americans’ wants and desires. Instead, continued recovery is going to require states to push ahead with reopening in a responsible manner.
Take New York and California. Daily new cases are down roughly 92% and 66%, respectively, from the peak in these states. Deaths are down, 99% and 40%, respectively as well. Yet both still have some of the nation’s strictest pandemic-related restrictions in place. This, in turn, has held back their economic recoveries.
According to August data from the Bureau of Labor Statistics, New York and California had unemployment rates of 12.5% and 11.4%, respectively, while the unemployment rate for the US excluding these two states was only 7.7%. If New York and California mirrored the nation’s unemployment rate, the result would be an additional 1.2 million Americans employed. New York and California combined have 18% of the US population, but 32% of all people receiving continuing unemployment benefits.
Just this past week, Florida (7.4% unemployment) and Florida (7.4% unemployment) and Indiana (6.4%) have fully opened their economies. These states, among many others, had lower unemployment than the national average, mainly because their shutdowns were less draconian. The competition between states that open and those that don’t – at the political, business, sports, school, and even family level – will lead to even more opening of the economy in the months ahead.
For a self-sustaining recovery to fully catch hold, it is reopening, not additional stimulus, that is the key.
The Long Slog Recovery!
First Trust Economics - September 21, 2020
The second quarter of 2020 was the mother of all economic contractions. Real GDP shrank at a 31.7% annual rate, the largest drop for any quarter since the Great Depression.
However, based on the economic reports we’ve seen so far, it looks like the third quarter will be the mother of all economic rebounds. Even if industrial production and retail sales are flat – unchanged – in September, they will still be up at 37.6% and 60.1% annual rates, respectively, versus the second quarter average. Total private-sector hours worked would expand at a 25.6% annual rate. Housing starts would be up at a 218% annual rate. (No, that last one is not a typo.)
The GDPNow tracking model, created by the Atlanta Fed, is forecasting that real GDP grew at a 32% annual rate in Q3. We’re waiting for data on inventories and net exports (which may pull down GDP growth) before committing to a growth rate over 25%. But, either way, it’s going to be the fastest real GDP growth for any quarter since World War II and we all knew it was coming. The first thing to recognize is that even if the real GDP growth rate in the third quarter equals or exceeds the percentage drop in the second quarter, the economy is still in a very big hole.
To illustrate this point and putting aside that GDP figures and percentage changes are annualized (which is a whole other issue), let’s take a company that produces 100 dresses each quarter. If production drops 20%, that means it goes down to 80 dresses. If production then goes up by 20%, that growth rate is from a lower base (80, not 100), so a 20% gain just gets you back to 96 dresses. It’s harder to grow out of a hole than it is to dig one.
The bottom line is that a full economic recovery in the US is still multiple years away. The surge in growth in the third quarter is largely related to many businesses going from a total lockdown to a new COVID-19 normal. Production and construction six feet apart, no fans in the stands, and 50% occupancy. Meanwhile, many small businesses (and some not so small) have simply disappeared.
This suggests that although growth should continue after the third quarter, it’s not going to be nearly as fast. You can only re-open your business once, not again and again (unless lockdowns happen again, which would send the economy back into negative territory).
We don’t think we get back to the level of real GDP we saw in late 2019 until late 2021. And that’s really not a full recovery because, in the absence of COVID-19, the economy would have grown 2% or more, per year, in the interim. If we define a “full recovery” as getting back to an unemployment rate at or below 4.0%, we’ll probably have to wait until 2023.
The pace of the recovery in 2021-22 will depend not only on the course of COVID-19, as well as development of vaccines, and therapies, but also public policy. Reducing overly generous unemployment benefits, even if gradually, would help get many back to work.
Some investors might be concerned about tax and regulatory increases in 2021, but it appears increasingly likely that any tax increases would not kick in until at least 2022 and maybe 2023.
If Joe Biden wins the Presidency and the Democrats take the US Senate, it would likely be by a very narrow majority. In that instance, we would imagine at least several Democrats balking at immediately imposing tax hikes. Remember, when President Obama took office in 2009, the Democrats had 59 seats in the US Senate, and taxes didn’t go up until 2013. This was because Democrats were hesitant to hike tax rates when unemployment was high and the economy was slowly recovering from the Financial Panic of 2008-09.
In addition, a President Biden would likely face a federal judiciary that more strictly limits federal regulators to issuing rules that stick to the laws passed by Congress and don’t go beyond. This makes executive orders “increasing” the power of regulators harder to push through than those that “limit” those powers. And the Supreme Court may get a
new member soon.
Either way, don’t expect the rapid growth in the third quarter of this year to last. It’s going to be a long slog back.