The U.S. Election and Tax Policy

Thoughts on the Market

Our U.S. Public Policy and Valuation, Accounting & Tax strategists assess the possible scenarios in the upcoming elections, and what they could mean for both taxpayers and the market.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US public policy strategist.

Todd Castagno: And I'm Todd Costagno, Head of Global Valuation, Accounting, and Tax Research at Morgan Stanley.

Ariana Salvatore: With less than a week to go until the US election, the race is still neck and neck. Today, we dig into a key issue voters care about: Taxes.

Todd Castagno: It's Tuesday, October 29th at 10am in New York.

So, Ariana. Taxes are an issue that impact both businesses and individuals. It's a key component of both candidates plans and proposals. How have they evolved over the campaign?

Ariana Salvatore: I'd say in general we do tend to see a lot of overlap between Harris' proposals and the ones that the Democrats were campaigning on before she took over the mantle from President Biden in July. That being said, in some instances, her plans go beyond what was requested in the president's fiscal year [20]25 budget request.

For example, that $6,000 credit for newborns and the $25,000 homebuyer tax credit. These are areas where we've seen her campaign go beyond the scope of what Biden was campaigning on while he was still in the race. Of course, it's important to remember that any of these proposals would have to pass muster in a Democrat controlled or a split Congress – meaning that there will be some tempering of these plans at the margin.

Todd Castagno: So former President Trump campaigned in his first election on tax policy. He's campaigning on tax policy in his current campaign. What are his plans and views?

Ariana Salvatore: We've been talking about the Republican sweep outcome as the most deficit expansionary from tax policy changes because Republicans understandably have more fealty to the 2017 Tax Cuts and Jobs Act.

That law is set to expire by the end of next year. So, in a Trump win scenario plus Republican Congress, we think you can get most of that 2017 law extended. While in a Trump win scenario with divided government, it's probably a little bit narrower. In general, as I said, deficits skew larger in Republican win outcomes for that reason, with an asymmetry across the other election scenarios. That being said, we do still expect to see deficit expansion in 2026, regardless of who's in power, because these tax cuts will be extended one way or another.

But Todd, you've done a lot of work in this area and there are some substantial impacts from a potential corporate rate increase to think through. Can you give us a little bit of detail on what that kind of increase would mean for stocks and bonds?

Todd Castagno: Yeah. So, investors have been very focused on the rate and where it matters and where it does not matter. So, if you really think about it, most companies that are exposed to a rate increase or decrease are domestic oriented, consumer companies, retail companies, you know, hospital facilities, industrials; those are the most exposed to a rate increase.

Multinationals this time around are less exposed. So, if we go back to 2017, we think about it; that was a different story. We had $2 trillion of trapped cash on the sidelines that did come back – buybacks, dividends, corporate hiring. You know, this time around, that's a different story. So there is exposure but it's mainly consumer-oriented companies.

Ariana Salvatore: That makes sense. And you mentioned the 2017 almost as a blueprint for what we saw last time. You mentioned dividends and buybacks.

Do you have any sense of how this time around could be different? What do we think companies would likely spend these tax cuts on?

Todd Castagno: Well, there are tax cuts. I do think it's going to be different. I do think the $2 trillion does not exist. That's not going to happen. So, you're going to have fewer buybacks, fewer dividends. But you could see some changes in employment. You could see some changes in investment. Things like upfront expensing could help boost the economy, higher jobs, et cetera.

One thing, Ariana. You know, tax cuts are expensive. I think that's what we've all contemplated for almost 10 years now. How are we going to pay for these in this new world?

Ariana Salvatore: Well Republicans have proposed a few different pay forwards. But to your point, we're not in the same environment as 2017, and we don't expect to see the same ones that were part of the original Tax Cuts and Jobs Act negotiations this time around. Specifically, former President Trump has talked about not extending the SALT cap, which was a revenue raiser that capped the amount of deductions some individuals could take between state and federal taxes. That provision raised about $900 billion over 10 years.

Republicans in general are mainly focused on peeling back some parts of the IRA – or the Inflation Reduction Act – as a cost saving measure, as well as letting some of the tax cuts from the 2017 law roll off.

We contrast that with the Democrat sweep outcome, where we could see a corporate rate increase to 25 per cent in our view, in spite of Harris’ pledge to bring it up to 28 per cent from the current 21 per cent.

Todd Castagno: So, we could talk about the Inflation Reduction Act for a second. You know, that was a bill that was designed to bring energy, clean energy manufacturing back to the United States.

It was a very large bill; it was partisan. But what do we think about in this next election outcome of actually repealing some of those items?

Ariana Salvatore: It's a great question. And Republicans on the campaign trail have been talking a lot about peeling back the IRA. Importantly, in our view, we don't think a full-scale repeal is likely even in a Republican sweep outcome. There are a few reasons for that, but mainly because if you look at where these projects are being located, it's in Republican held states and districts. And Republicans in the house currently have said that they're not interested in rolling back the law. That being said, there are ways to potentially cap the amount of outstanding money that has not yet been allocated.

And the president could work with the treasury or other federal agencies to tighten up some of the criteria or the guidance around accessing some of the tax credits that will limit the overall deployment.

Todd Castagno: I think the recent Supreme Court decision also plays into that.

With candidates’ tax plans – I’ve run a lot of numbers from a company perspective. You've run a lot of numbers top down from a deficit perspective. What did you come to view?

Ariana Salvatore: We do see deficits expanding in 2026 and beyond. That's because, in our view, it's not really in lawmakers’ interest to allow all of the tax cuts – both individual and corporate – from 2017 to expire. We think the largest extension, as I mentioned before, comes in a Republican sweep. But in general, in some form or another, we think that at least a portion of these lower tax rates are going to stay around.

That adds $2.8 trillion to the deficit over 10 years on the high end per our estimates; and $700 billion over 10 years in our smallest expansion scenario, a Democrat sweep.

So finally, Todd, in either win outcome, what's the timeline of key tax-related events that investors should be paying attention to?

Todd Castagno: So, this is the trillion-dollar question. So, most of the individual side of the tax cuts and jobs act expires at the end of 2025. There are certain business provisions that have already started to phase out. There are certain provisions that are permanent, like the corporate rate.

When will Congress get to this? They will get to it at some point, but we just don't know when that is. Could it be early 2025? Could it be 2026? And I think investors should pay attention to that because Congress doesn't always act on time; and we also don't know what the extensions will look like. Some things could be extended three years, five years, 10 years. Some things could be permanent.

So that's the jigsaw puzzle that we'll have to put together after the election.

Ariana Salvatore: Great. Well, I guess three things in life are certain – death, taxes, and the fact that we will be following this issue very closely.

Todd, thanks so much for taking the time to talk.

Todd Castagno: Great to speak with you.

Ariana Salvatore: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share the podcast with a friend or colleague today.