2021 Economic Forecast – Pt. 3 – The Biden Tax Plan

Part 3 of our 2021 economic forecast will examine Biden’s proposed tax plan and it’s effect on the US economy, including an overview of the proposed changes and their impact on investments and asset prices, as well as minimum wage increases and unemployment rates, and post-crisis stimulus and recovery.

And in case you missed them, here are part 1 and part 2 in the series.


Hi, this is Bob Fraser, founder of Aspen Funds. And this is the third part in our economic forecast for 2021. In this section, I’m going to look at the Biden tax plan, and its likely economic impact into 2021 and beyond. So, here we go.

The Biden tax plan, of course, the big question is, will it pass? As I sit here contemplating this, there’s still a question of the makeup of the Congress and whether how many votes he will have, and whether or not he will be able to pass this. But I’m going to assume that this passes and we’ll look at what the potential effect is here.

Here’s a quick overview of his tax plan, and the biggest thing is the capital gains tax rate is almost doubling from a 20% capital gains to a 39% tax capital gains. This is of course a long-term capital gains. You buy an asset, you hold it over a year, and then you sell it, you would pay about 20% pre-Biden. Post-Biden, you’re paying almost 40%. So massive, massive increase, we’ve never seen anything like that. And so the result is a question mark, but we’ll look at the past and what has happened as a result of this.

The other big change is the corporate income tax rate. In 2018, Trump passed this 21% tax, massively reducing the corporate income tax rate, and Biden proposes to increase it to 28%–so fairly significant–and reintroduce the alternative minimum tax. There were also a couple other changes here, but I’m not going to focus on these as they’re a little smaller in their impact. I’m going to look at the first two measures.

Let’s look at this long-term cap gains tax rate increase from 20 to 39% on income over a million dollars. It’s primarily going to be businesses that are affected or wealthy individuals. Now, this is from Goldman Sachs here, this chart, and they looked at previous capital gains tax increases in 1981, 1988 and 2003. And basically what happened in those cases, the S&P dropped significantly, but then within six months had recovered. The household equities dropped, the investment of households in the stock market, and Momentum clearly dropped but then recovered. In all three of these cases there was an impact, but it was pretty quick in its recovery. My opinion is this is going to have a quite chilling effect on investment and also prices, primarily in real estate and in the stock market.

Combined with the elimination of 1031 exchanges, it’s going to have a significant depressive effect on real estate, liquidity and pricing. With a 1031 exchange, as anyone in real estate knows, you can sell an existing property, buy a new property, and basically swap out your cost basis, in essence, and defer your taxes. This has been a pretty big tax savings for real estate investors.

Here’s Goldman’s take on the eliminating of 1031 exchanges: “Eliminating 1031 exchanges would likely lead to a decrease in commercial real estate prices in many markets, less reinvestment in commercial and residential real estate, greater use of leverage to finance acquisitions, and an increase in investment holding periods that would result in a decrease in market liquidity and a slow-down in related industries.” So a lot of people will simply hold their existing property rather than sell and pay the taxes. It means fewer properties available for sale, less liquidity in their terminology. Possible sell-off in stocks and commercial real estate prior to a cap gains tax increase.

So again, according to Goldman, history shows stock prices fall, equity allocations decline, and Momentum underperforms ahead of increases in capital gains tax rate. However, any potential equity selling will be short-lived and reversed in subsequent quarters. So they are quite positive about it, and I believe it’s going to possibly create a selling, but it’s going to be a quick recovery. I’m not so sure because of the sheer magnitude of the increase, we have never seen a doubling of taxes and capital gains combined with 1031 exchanges. This could be more pronounced.

The other thing that’s very different from these periods that Goldman mentioned is today’s wealthiest households are sitting on $1 trillion in unrealized equity gains. So let’s say you’re an investor and you have $1 trillion, and you have $1 billion in gains. And the tax rate is going to double on January 1st, what are you going to do? Why you’re going to sell that thing and you’re going to pay your taxes, and then maybe buy it back. So we’re going to see a lot of big selling crush, this is about four times larger than it’s ever been, 4x larger this number. There’s a lot of incentive to sell. I believe we’ll see a sell off if it ends up being effective in January 1st of ’21, we’ll see a possible market sell-off in Q4 in anticipation of that, and possibly a little bit of a depressive effect on long-term prices.

We’re already seeing it in private mergers and acquisitions, with a lot of private companies that are privately owned that are looking to sell. They’re going to move all that forward and we’re seeing a huge amount of M&A already hitting as people who are wealthy business owners looking for exits are going to move that forward again because they’re going to save in taxes. So this is possibly a very significant tax increase.

The one that is even more concerning to me is this corporate income tax increase from 20% to 28%. The Trump tax plan was absolutely a revolutionary plan. He reduced corporate taxes to global norms.

The US was one of the highest tax jurisdictions in the world for business taxation. It really penalized US-based businesses, and the US was the only country in the world that actually demanded that US corporations pay taxes on foreign earnings. So if you have a foreign subsidiary, you pay US taxes on that. And so what happened is businesses basically didn’t pay the taxes, they just held them in those foreign entities. Trump allowed them to repatriate all that cash, it was trillions of dollars, and pay their taxes on that. It eliminated this very weird disparity of the US corporate taxes in the globe. And I said at the time it was going to dramatically impact the economy. In fact, it did.

This tax change was the largest single factor in driving pre-COVID unemployment rates to historical lows. This is the unemployment rate for black or African-Americans, and we saw literally setting a record low. And for Hispanics as well, also a record low, never seen before. So basically, contrary to politicians’ economic fantasies, jobs are created almost entirely by healthy businesses. When businesses are healthy, they hire people. And that’s exactly what happened as these businesses were flushed with cash, they began hiring, and you see this trend continue down here.

There’s also, Biden has pledged to boost the minimum wage to $15 an hour. I understand that that’s the desire to create a livable working wage for that, but it actually has a very detrimental effect. Raising minimum wages will have a very detrimental effect on the marginally employable and youth looking for their first job. You think about someone coming out of high school and they really have no skills whatsoever, and really not even any work ethic. What are you going to pay them $15 an hour to do and actually have it make sense?

For part-time workers, those without deep skills and job history, it’s going to have a very, very difficult effect. I was thinking about a friend of mine who runs a computer recycling business and he actually pays homes for the severely mentally handicapped to destroy and disassemble computers. And if he had to pay them $15 an hour, well, they would shut them all down, right? You can’t afford to do that anymore. And so what happened is people who are working then don’t work. And it’s a long-term effect delaying and/or preventing the marginally employable from entering the workforce. That first job is so hard to get, and now raising the minimum wage or increasing the high jump bar for that first job creates a long-term burden of support on society and will unequally affect the poor and people of color, unfortunately.

What a lot of politicians don’t realize is US workers compete for jobs with global workers and automated solutions. We’re already seeing automated kiosks at McDonald’s and others because they’re cheaper. It’s cheaper to spend $10,000 for a kiosk than hire a worker. And so a worker competes with a computer and an automation solution, and also competes with (though not in McDonald’s, but in manufacturing and others) global workers. So it’s going to have a depressive effect on employment, unfortunately. I appreciate the heart to do that, but it needs to be tailored so that there are exceptions to the $15 an hour rule. We’ll see what actually passes, if there are exceptions, then this will have not as detrimental effect.

Bottom line is the stimulus measures supersede all. According to Goldman Sachs, “Our political economists outlined roughly $7 trillion in gross fiscal expansion spread out over several years that Biden has proposed, including $2 trillion of front-loaded COVID stimulus, as well as spending on infrastructure, healthcare and other policies.” If this is $1 trillion, if it’s seven trillion, that is going to be a massive stimulus effect, either one of these is going to be massive stimulus and their effect. And so, that really trumps everything else. It is the greatest effect. We’ll see as he takes office what actually he is able to pass. So it will have a varying effect.

For comparison, early 2020 stimulus measures totaled $2 trillion with another $0.9 trillion in December. So we’ll see what spending happens. Even if nothing happens, we are still going to see a fairly strong economy simply because of what has already been spent working through the economy. But if the spending continues to this level, we’re definitely going to see a boom and it’s going to primarily affect asset prices again.

A lot of people are concerned about the deficit spending and the monetization of debt that the Fed is doing, and we’re going to talk about that in another session.

Obama was elected at the tail-end of the global financial crisis, his term was marked by historical stimulus and deficit spending, both central bank and government spending, and emphasized social spending and policy. And the effect was a recession that was just stubborn, we could not get out of it. This chart shows job losses since post-World War II recessions. And so they all took a couple years. So these are months. So this is, four years here, three years, two years. So you can see how long it took for these recessions to work out. Here is the 2007, the Obama recession, and it took six and a half years to recover. Now, it was deeper, you know, but it also was much slower and longer recovery. This was partly because it was a systemic crisis, but partly because social spending doesn’t necessarily help jobs. And the historical level of spending here basically increases asset prices. So what we saw is slow job recovery, but great asset price recovery.

The big question is will Biden’s tax plan pass and will there in fact be $7 trillion in spending? I doubt it’s going to be that high, but there’s likely to be more coming beyond what was passed in December.

The bottom line is Biden was elected at the tail end of the COVID crisis, his solution is very similar to Obama’s and I expect to see the same two results, again, massive asset price inflation and a slower jobs recovery. However, Biden’s job recovery will not be as slow as Obama’s because the COVID-19 shock is an exogenous shock versus systemic, it’s an external shock. And you can see already right here, this shock, we’ve never seen anything like this. The speed of the job losses, but we also have seen nothing like the speed of this recovery. So again, because the policy makers and Congress acted so quickly, I would expect to see this going here. But again, because of the policies, it may take a little bit longer. But not nearly as long as the 2007 recession. So there’s our bottom line on the tax changes for Obama.

Next, we’re going to look at the real estate market and what is going on in the real estate market and what is going to likely happen in 2021.

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2021 Economic Forecast – Pt. 1 – The Economy

2021 Economic Forecast – Pt. 2 – COVID19 Recovery

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