Have you noticed Washington’s newest magic trick—The Incredible Shrinking Tax Hike? Since President Biden officially released his slate of proposed domestic and global tax increases, he has spent much of his time walking them back and forward … and back … and back, wooing much-needed moderate Democratic and Republican support. At this rate he could be pitching tax cuts by late October as the new fiscal year dawns and the 2022 election cycle kicks into gear.
Pundits initially paranoid of far-flung, extreme scenarios now struggle incomprehensibly with what stocks knew all along: Sneaky legislative gridlock torpedoes huge hikes—and most controversial changes. This is the basic scenario behind Democratic presidents’ historically gangbuster inaugural-year stock market returns. It’s happening now. Let me show you.
In March, I told you Biden’s hopes for huge tax hikes and drunken sailor spending were pipedreams. Razor-thin Congressional margins render Democrats’ legislative “control” largely a mirage. They can afford zero dissent in this Senate—and next to none in the House, where their edge is the smallest for any newly elected Democratic president since Grover Cleveland. Impending redistricting further squeezes moderates to the now near non-existent ideological center.
Pundits have mostly ignored these realities, instead claiming rising stocks “ignored” Biden’s plans. They penciled in the corporate, personal income and capital gains hikes he proposed and shrieked about potential others. Now reality arrives. Biden sought $2.3 trillion for his infrastructure plans just weeks ago. Pundits were sure it would pass. But the infrastructure deal he struck with centrists comes to $973 billion spanned over five years. Even then, only $579 billion is actually new spending. The broad tax hikes Biden wanted to finance his plan? Sayonara, baby!
Yes, that deal could grow to $1.2 trillion if it gets extended to eight years. But that is a big if—and still down significantly from early plans. All this merely to garner enough support to bring forward a proposal still far from guaranteed to pass at all! The more Biden moderates, the more he risks alienating far-left Democrats who crave hugely bigger changes centrists oppose. All this haggling could leave him back at square one as 2022’s election shadow grows. But getting through the Senate takes time and there are only 24 scheduled days of Senate convening between now and when campaign season full tilt boogies. Talk about threading the eye of a needle.
Even new infrastructure funds may not be “new.” The White House cited unspent COVID relief funds—some $1.6 trillion sits idle—as one possible source of financing the “new” spending. It’s a much-used shell game few fathom—legislators earmark the same dollar for multiple purposes as priorities shift. They can cite redirected old funds as hard-fought “wins.”
What about capital gains tax hikes? Montana’s Democratic Senator Jon Tester labeled Biden’s plan to eliminate the cost-basis step up at death—a non-starter. Democrat Robert Menendez of New Jersey expressed similar reservations. Even the proposal’s smaller pieces—like curtailing capital gains tax deferrals on some real estate sales (1031 exchanges)—are getting pushback. Armies of accountants search for workarounds to each and every provision. One study estimates Americans can avoid 90% of the planned hikes perfectly legally.
Scary hikes are shrinking overseas, too. Initially, Biden wanted a 21% global minimum corporate tax. Immediate opposition forced him down to 15%. The G7 recently agreeing to the latter means diddly. Ditto if the G20, backs that plan as expected in July. The tax to be effective requires near universal support—not just that of most of the world’s richest nations. Longstanding objections from Ireland and other non-G20 tax havens remain. US agreement isn’t even guaranteed for all the above stated reasons. Biden needs democrat unanimity. Note disagreement rages over defining even the revenue subject to tax, potential industry exemptions, and limits on countries compensating firms for taxes paid. This global tax goes nowhere soon, if ever.
The longer talks linger, the less likely big changes become. The 2022 campaign is two blinks and a nose sniffle away. The president’s party almost always loses seats. Democrats in contentious districts will be doubly cautious of supporting controversial legislation with Congressional redistricting in between now and election time. The once-a-decade reapportionment of House seats based on 2020’s census causes 13 states to embark on the contentious process of redrawing district lines. Uncertain of who their future voters are, several dozen representatives will shun extreme legislation to protect their own hides. That births gridlock on steroids.
Markets foresaw all this coming. Their main job: pre-pricing all widely known information and opinions—a key lesson so many investors ignore. Stocks didn’t “ignore” tax hike chatter. Observers ignored stocks which never, ever ignore any headline story. They simply knew Democrats’ tiny margins and internal squabbling would eventually squash or drastically dilute any tax proposal. Now it comes.
That is gridlock’s beauty: It decreases uncertainty, allowing businesses to invest and plan without fearing catastrophic changes that could imperil them. As I explained here last October, investors typically paint newly elected Democrats as anti-business, based on promises like Biden’s. When gridlock blocks and, or, dilutes them, relief ensues, buoying stocks. No shock, then, that the S&P 500 averages a whopping 21.8% in newly elected Democrats’ inaugural years. If the past few weeks’ events are any indication, that is playing out perfectly now.
