Potential Impacts of Political Shift in the United States

Too often American politics can be a political tit-for-tat that includes reversing course on policies and agendas set forward by the previous administration. The Affordable Care Act serves as a prime example. The policies that were set forward by the Obama administration have been either dismantled or are in court to be reversed by the Trump administration. This includes the American stance on environmental policies.

The same tit-for-tat game is being promised, at a varying degree, by Biden’s political agenda, if he is elected. One of those things, as aforementioned, is the reversal of tax reform laws signed by president Trump in his earlier years in power. These tax laws served as an overhaul to the previous tax rules, especially for corporate taxation and tax for wealthier Americans.

The Tax Cuts and Jobs Act was signed into law by President Trump in December 2017, hailed by the Republican Party as a tax reform inclusive to all, but some highlighted the tax cuts that mainly benefit wealthier Americans. Here were some of the objections raised by economists:

 

• A huge disparity in tax reductions, with the top 1% of Americans by wealth, saving an average of $35,000 in tax cuts while the bottom 10% saves on average $50.

• The corporate taxes went down from 35% to 21% and some argued that these tax cuts went to high-paying executives and pass-through income to individuals that owned large stock holdings in these companies as it ultimately affected the corporate net income, since the bottom 80% of Americans, by wealth, own less than 10% of the stocks.

• The reformation of the estate tax that benefited the ultra-wealthy individuals.
  Biden, if elected to become the 46th president of the U.S, is likely to reverse course on all of these tax breaks and introduce his own tax reform, which he has claimed to be more inclusive of the middle class and Americans in the lower part of the wealth totem pole.

It’s important to note that in a well-functioning democracy, dogmas can’t run political parties; post-election, there is often a moderating influence that brings both parties to a more bi-partisan decision making. The same is applicable to American politics, and the moderating influence is exerted by the Senators and representatives elected to the American Senate and the House.

Having said that, Biden, if elected president, will likely settle on a give-and-take scenario for his own tax reform bill. However, some things that will likely be eliminated are the tax cuts for wealthy individuals and increasing corporate taxes. If these things are implemented, here is how it will likely impact the fixed-income markets:
 

• The most well-known fact about municipal debt is its triple tax shelter from federal, state and local income taxes. This means that the semi-annual coupon payments on the municipal debt is not treated as regular income, unlike the income from equities or corporate debt coupon payments.

• It’s important to note that the higher the income tax bracket, the more the savings from owning municipal debt. Here is an example: Investor A earns $80,000 from his salaries that puts him into the 22% income tax bracket. Let’s assume he invests his savings in a mix of equities and corporate debt that generates an additional income of $10,000 for that year. This means that his income from investments will place him in the new income tax bracket of 24% for additional income. However, if this income was generated through municipal debt, he would’ve retained his original tax bracket.

• This tax-free income benefit increases as your income tax brackets go up, which means that wealthier Americans are likely to benefit much more from the tax-free income than those belonging to lower tax brackets.

This being said, the elimination of President Trump’s tax cuts will certainly bring an influx of capital to the municipal fixed-income markets in the upcoming years, which also means that municipalities may benefit from the increased interest in the municipal debt and lower their coupon payments.

Use our Screener to find the right municipal bonds for your portfolio.

American politics is as unpredictable as the British weather. The forecast into Biden’s presidency can only be based on his political policies and agendas, assuming he wins the election in November 2020.

If President Trump prevails, we are not likely to see much of a change in the American tax system, and investors will likely favor equities over tax-free income.

Sign up for our free newsletter to get the latest news on municipal bonds delivered to your inbox.

Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgement of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisers prior to making any investment decisions.