Before the first Presidential debate ended Monday night between Hillary Clinton and Donald Trump, where each candidate exchanged sharp attacks, political watchers were weighing in on how each nominee, and a new Congress, will impact the economy and fiscal policy.
Because Clinton will face a Republican-controlled House, the “honeymoon” period that typically follows a presidential inauguration will be compromised, with a “contentious relationship” being ushered in between the House and the White House if Clinton prevails, said Andy Friedman of the Washington Update in his latest white paper.
House Republicans will be “exceedingly unlikely” to agree to Clinton’s call for higher tax rates and higher domestic spending, so a Clinton presidency would continue the Washington gridlock that has been the status quo since the GOP took control of the House in 2010, Friedman said.
“Few initiatives will be enacted and sweeping legislation will be scarce to non-existent. Instead, Washington will address fiscal deadlines with eleventh-hour short term extensions, kicking the can down an abbreviated road.”
Gridlock is notably frustrating to many American voters, however it’s not necessarily detrimental to the markets, Friedman opined. “Markets react negatively to uncertainty. When one party controls the White House and Congress, the possibility of sweeping legislation antithetical to businesses remains a possibility.”
While Clinton has been calling for increased taxes on the wealthy, Trump would reduce taxes “significantly across the board,” Friedman noted, a plan that would be well-received by House Republicans.
However, although markets “initially might cheer lower taxes,” he continued, “the negative consequences to the federal deficit of more spending and reduced taxes could cause overleveraging problems down the road. Thus, a Trump presidency could follow the arc of the George W. Bush presidency, with exploding debt leading to an economic (and market) downturn.”
Further, because Trump is “anything but predictable,” Friedman said, “that attribute alone has the potential to roil the markets.”
A just-released report by WalletHub in which analysts compared the state of the economy during Democratic and Republican years 1950 to 2015, found that the economy has performed best under the combination of a Democratic presidency and Republican Congress.
The WalletHub report cited a recent Gallup poll which found the “economy in general” was the major concern for a majority of respondents.
The stock market has also performed best under a Democratic presidency and Republican Congress, the WalletHub report found, with the S&P 500 producing an average annual return of 17.03%. It performs worst under a Republican presidency and divided Congress, with an average annual return of 3.28%.
Citing an August Congressional Budget Office report, Friedman noted the deficit is now rising again: the 2015 deficit will grow by a third in 2016. Even in the absence of additional spending, “this deficit increase will accelerate in coming years as major entitlement expenditures (Social Security and Medicare payments) grow with the aging population,” he said.
But neither Clinton nor Trump seeks to reduce the federal deficit, he pointed out. “With spending up, entitlement reform off the table, and the deficit growing, we believe the deficit hawks in the House leadership will be forced to undertake a constant search for revenue,” Friedman said.
Republicans will not seek to enact broad tax increases—such as higher tax rates or the elimination of popular deductions or exemptions, Friedman continued. “Instead, the House leadership is likely to look at less controversial tax changes—smaller items that curtail tax treatment that many in Washington believe is inappropriately generous,” a process he argued has already begun.
The last government funding compromise last December sought partially to recoup increased spending by eliminating a popular—and, in the eyes of many politicians, overly generous—Social Security planning strategy called “file and suspend,” Friedman noted.
“We believe eliminating the ‘file and suspend loophole’ is a harbinger of things to come,” he said, as future funding bills could close other perceived loopholes, “resulting in a whittling away of techniques investors use to reduce taxes.”
Some of those other loophole closures under discussion, Friedman said, include:
• Taxing the sale of “carried interests” as ordinary income.
• Curtailing “stretching” of inherited IRAs and 401k’s.
• Applying required minimum distribution rules to Roth accounts beginning at age 70-1/2.
• Limiting Roth IRA conversions to pre-tax dollars.
• Treating all distributions from S corps and partnerships to owner-employees as subject to employment taxes.
• Curtailing sophisticated wealth transfer techniques.
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