From the October 2004 issue of Investment Advisor • Subscribe!

October 1, 2004

The Contenders: Election 2004

The Presidential candidates have different priorities on the markets, the economy, taxes, and regulation. Here's what they say they'll do if elected

The Presidential election is only weeks away now, and it's still anyone's guess as to whether George Bush will be reelected on Nov. 2 or a new John Kerry administration will be installed in January. For months now, talking heads on cable news shows, industry analysts, and everybody in between have debated whether a Bush or Kerry Administration would be better for the economy, financial markets, and the country as a whole. While studying the potential effects of a Presidential candidate's platform is standard practice, it isn't really the best way to gauge what will actually occur during a President's time in office. What matters most is how amenable Congress is to passing what's on the President's agenda. Rarely have Democratic Presidents been able to get much done under a Republican Congress, and vice versa.

Jonathan Golub, a VP and U.S. equity strategist at JPMorgan Fleming Asset Management's retail business, remembers how impossible it was for former Democratic President Bill Clinton to get his health care reform package through a Republican Congress. "It never happened," Golub recalls. If Kerry is elected, Golub predicts he'll have a bear of a time getting his proposed tax package through the current Republican-controlled Congress. While taxpayers will likely see higher taxes no matter who's elected--thanks to the huge deficit Bush has racked up--Kerry's more aggressive stance on raising taxes on the wealthy will likely turn out to be "more benign" than he's proposing, Golub says.

Capital Gains, AMT, Dividends

Taxes have been a big campaign topic for both candidates. If elected, Kerry promises to boost the long-term capital gains rate to 20%. That's why planners have been counseling clients with huge capital gains to take them this year so they can take advantage of the current 15% rate, which Bush instituted through JGTRRA and has said he would maintain. But Kerry says he would cut the capital gains rate to zero on startup investments held for more than five years in certain small businesses. In addition, Kerry promises to raise the top rate on dividends to as high as 39.6% for high-income individuals. It's uncertain at what income level that rate would kick in, says Bill DeReuter, government relations assistant director and tax expert with the Financial Planning Association in Washington, but Kerry has proposed raising taxes on those who earn up to $200,000 annually.

Both Kerry and Bush would also extend the Alternative Minimum Tax (AMT) relief for one year. "Bush has asked Treasury to study the AMT and propose a long-term solution," DeReuter says. And "Kerry has indicated he would work with Congress to find a long-term solution." Fixing the AMT will lead to tax reform and revising the tax code, DeReuter says, because an AMT overhaul would require "revisiting the rates." (For a comprehensive look at the AMT, see this month's ).

Bush has said he would make permanent the tax cuts implemented through his two major tax initiatives--the Economic Growth and Tax Relief Reconciliation Act of 2000 (EGTRRA), and the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), which became law in 2003. That would keep intact the top income tax rate of 35% and the 33% top rate on dividends. As mentioned, Kerry would raise the top marginal tax rate from 35% to 39.6%, and boost the current 33% dividend tax rate to 36%. In addition, "Kerry has suggested unspecified tax cuts for lower-income households to help pay for college, childcare, and healthcare," DeReuter says. Moreover, "Bush has said he wants to create a bipartisan commission to reform and simplify the tax code," he says, "which has long-term implications for planners."

As for the estate tax, Bush wants to make the repeal of the estate tax permanent. Kerry doesn't. Kerry "would raise the basic exemption to $2 million immediately, and would set a $10 million exemption for small businesses and family farms," DeReuter says. "The exemption on the Kerry side would grow with inflation."

Retirement Planning

Bush failed to mention his retirement proposals--Lifetime Savings Accounts (LSAs), Retirement Savings Accounts (RSAs), and Employer Retirement Savings Accounts (ERSAs)--during his acceptance speech at the Republican National Convention in New York in August. Some analysts have said the proposals are part of Bush's tax package. Kerry hasn't said a word about the plans, so it's unclear if he would brush them aside if elected.

Several tax provisions expire this year and must be extended--the marriage penalty relief, the one-year AMT relief, the child tax credit, and expansion of the 10% tax bracket. DeReuter says he expects Congress to extend all of the provisions this year. "There doesn't seem to be any disagreement [among members of Congress] that those [provisions] need to be extended," he says. "The debate is really over how long to extend" them.

If Bush gets in for a second term, his proposed private accounts for Social Security may come back into the light. Planners would likely be able to use the accounts as an estate planning tool for their clients. The Bush team has divulged "precious few details" about the accounts, according to DeReuter, but the intent would be to allow taxpayers to "direct a portion of their FICA taxes to a personal account" that would be part of their investment portfolio. Investors would "maintain ownership of the account throughout their lives," and the money could be passed on to their heirs.

DeReuter says Kerry is considering raising the maximum amount of income on which FICA taxes can be levied from the current $87,900 to $120,000. Another Kerry proposal that shouldn't be overlooked is his plan to eliminate a domestic company's ability to defer taxes on its foreign income. Instead, Kerry plans to "provide a special one-year 10% tax rate for overseas profits that are reinvested in the U.S. under a domestic reinvestment program," DeReuter explains. "So for one year, Kerry would lower the corporate tax rate 1%, and use those savings to lower the overall corporate tax rate to 35%."

On the corporate side, Kerry would cut the top rate to 33.25% from 35%, and provide a new jobs tax credit for manufacturing and industries affected by outsourcing, DeReuter says. Bush "has lent tacit support" to the Foreign Sales Corporation Extraterritorial Income Act, which is called the corporate tax bill in the House (H.R. 4520) and the jobs bill in the Senate (S. 1637). There are "major differences" between the House and Senate bills, but H.R. 4520 "would cut the corporate tax bill for small corporations to 33%, and expand the corporate AMT exemption for small business," DeReuter says. It's unclear if Congress will pass the bill this year. "The pressure to get [the bill passed] is being driven by European Community sanctions on U.S. products that are exported," DeReuter explains. "Currently, the sanctions are at 11% and will rise 1% each month until Congress can repeal what used to be called the Foreign Sales Corporation regime, but it's actually called the Extraterritorial Income regime. The sanctions are starting to hurt domestic manufacturers that export, and multinational corporations."

Who's Best?

The age-old debate of which political party is better for the markets lives on. Most studies have shown that the stock market performs better under a Democratic President, while bonds flourish under a Republican one (see "Who's Better?" sidebar, below). If Kerry wins, "the market assumption is that we will have a higher-tax, more-protectionist, lower-growth environment, which would result in lower inflation and lower interest rates. So bonds win," says Golub with JPMorgan Fleming. A Bush win, on the other hand, means a "more aggressive environment, with a higher deficit--which would be inflationary, faster economic growth, and less protectionism, [so] interest rates rise and bonds lose relative to equities."

As it stands now, the market is anticipating a Bush victory, and he is ahead in the polls, Golub says. In April, Bob Doll, president and chief investment officer of Merrill Lynch Investment Managers, predicted in his "What's Ahead in 2004" investment report that "the Republicans will hold the White House and Congress, but probably not by enough to push through all of the items on the GOP's wish list."

If there is a last-minute shift in the outcome, and Kerry wins, investors "may think about allocating stocks to bonds and allocating differently with respect to very specific stock and sector issues." For instance, everyone predicts pharmaceutical stocks would do poorly under a Kerry Administration, but it's Kerry who would "likely move forward stem cell research, which would be great for biotech" companies. "So you may see a rotation away from very specific names or small groups of stocks" if Kerry wins, Golub says.

As for the economic outlook, Federal Reserve Board Chairman Alan Greenspan told Congress in September that the U.S. economy has edged up since tailing off in late spring. But Greenspan warned Congress that the "outlook for oil prices remains uncertain." Skyrocketing oil prices, fears of terrorism, and angst about the Presidential election are keeping investors at bay for now. All of these variables are eroding advisors' confidence as well, according to a recent Advisor Confidence Index survey performed by AdvisorBenchmarking.com, a division of Rydex Investments. Jim Elder, a planner with ElderAdo Financial in Montrose, Colorado, says the stock market is "in a wait-and-see attitude until visibility is clearer with the Presidential election, energy prices, interest rates, corporate earnings, and terrorist threats." Ted Feight, a planner with Creative Financial Design in Lansing, Michigan, says he's "started using more index stocks and putting stops on them in case of a terrorist attack just before the election."

Ron Keleman, a planner with The H Group, Inc., in Salem, Oregon, is telling his clients not to bet their portfolio on a certain election outcome. "Too many other factors affect investment results," he says, "and elections can be unpredictable." Golub of JPMorgan Fleming agrees, arguing that, "At the end of the day, I don't think the [election] outcome is as important as we'd all like to think it is. Americans create wealth and profit, not the people in Washington D.C. by setting policy."

Stricter or Looser?

What about the regulatory environment under Bush and Kerry? William Donaldson, chairman of the Securities & Exchange Commission, was appointed by Bush and has been credited with turning around the embattled SEC, unleashing a bevy of new rules to reign in a scandal-ridden mutual fund industry, corporate wrongdoers, and hedge fund managers. Investment advisors have been on the receiving end of Donaldson's regulatory crusade. If Bush goes, you can bet Donaldson will resign. If Kerry wins, he'd likely appoint a new chairman, and Donaldson would have to fill out his term as a commissioner, not as chairman. But would Kerry be able to pony up a suitable candidate to replace Donaldson? As with the outcome of the election itself, we don't yet know the answer.

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@ia-mag.com.

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