Washington Watch: Impacts of the Blue Ripple

Washington Watch: Impacts of the Blue Ripple

February 03, 2021

By just about the slimmest of margins, Democrats have control of both the House and Senate.  It wasn’t quite the wave many predicted, leading some pundits to term it a blue ripple instead of a blue wave.  Nonetheless, we have understandably been receiving quite a few questions about potential impacts to investors under the new administration.  Before even talking about policy, I think it is worth thinking about how this will work procedurally. 

Slim majority makes things more difficult for Democrats

The Senate is split 50/50 for democrats and republicans, with the tiebreaker vote belonging to Kamala Harris and the Democrats.  In the house, Democrats hold the majority 221 vs. 211.  While that does give Democrats control and certainly an edge in passing its policy, the majority’s slim margin will likely temper some of the more out there proposals.  Remember, each member is on their own ideological spectrum, from democratic socialists like Bernie and AOC, to progressives like Elizabeth Warren, to more moderate Democrats like Joe Manchin and Jon Tester.  Democrats will need stay completely unified and potentially even pick up some Republican votes to offset defectors (looking at you, Susan Collins) to pass legislation.  I believe this makes it harder for some of the more radical and controversial policy ideas we heard about during election season to be passed, such as increasing taxes on capital gains.  Watered down moderate versions of those campaign policies are more likely.   

Filibuster battles

Just because Republicans are out of control does not mean they do not have any power.  In the Senate, 60 members are required to move topics from a debate to a vote.  If fewer than 60 members do not support moving the topic to vote, that measure is filibustered and goes nowhere.  Seeing as the Democrats only have 50 seats, this could pose a big hurdle for them in passing legislation.  Although, they have a few options. 

Similar to the 2017 Tax Cuts and Jobs Act’s path, Congress can pass legislation through policy stuffing budget reconciliation measures, which only require a simple majority. Budget reconciliation bills can normally only be used once per year, but since the outgoing Congress never finalized the 2021 budget, Democrats get two opportunities this year. 

There is also the potential that the filibuster rules get changed.  Both Republicans and Democrats have eased filibuster powers in respect to blocking nominees to lower courts, government positions, and Supreme Court Nominees.  A fight to change more filibuster rules is very likely, but it may be a tough path for Democrats due to the slim majority.  For example, Senator Joe Manchin, Democrat from West Virginia, is emphatic and vows that he will not vote to kill the filibuster.  The filibuster battle is one to watch closely for anyone worried about potential policy from the new administration.

Policy Agenda and Impacts to Investors

First off, I plan to write more in the coming months about how we see policy from the new administration impacting investors.  For now, I will start with two.  Additional government stimulus is likely to be the first major policy to be enacted (ignoring executive orders).  I also want to touch on tax reform since it is far and away the most frequent question that we receive concerning potential negative impacts. 

It is highly, highly likely that there is more stimulus (government cheese) on the way.   President Biden’s team is proposing a 1.9 trillion dollar package while the Republicans counter at 618 billion.  In my mind, it’s not a question of if a new stimulus package gets done, it’s more of a question of what is included in the final bill.  Still in debate, how much is in checks, what will the income caps be to receive those checks, what will go to state and local governments?  While it’s hard to wrap my head around how more deficit spending is good in the long run, this likely is market positive in the short run.    

As mentioned, by far and away, the biggest political type question we get is related to President Biden’s tax plan.  If you looked at his tax plan during campaign season, you saw that the increases were especially targeted towards income earners over $400,000.  He also proposed reducing the estate tax exemption to $3.5 million and increasing the top estate tax to 45%.  His campaign proposals also included increasing the corporate income tax from 21% to 28%.  To be sure, there have been more proposals out there, such as eliminating the step-up in cost basis, increasing the capital gains tax, adding a financial transaction tax, a wealth tax, and so on. 

You add it all up, and it paints a somewhat scary-looking picture, but remember a few things.  First, we are still in a pandemic.  Increasing taxes this year while at the same time sending out stimulus checks doesn’t seem like it will happen.  Democrats have a 2-year window until the next mid-term election put their majority at risk.  I believe there will be talks on tax increases this year, but I do not think any changes will apply for 2021.  Next year is a different story.  That should give investors time to change strategies before any potential new plans are in effect.  Second, tax increases are controversial.  As I wrote about before, with the slim majority in both the House and Senate, I believe a passable tax plan will be watered down and less extreme than any campaign proposal.  Tax increases are negative for the markets, but I encourage you to wait and see what is actually coming before making changes. 

Before the election, we reminded followers that what is proposed in political agendas and what is actually passable, are not necessarily the same thing.  In the coming months and years, I think that broken campaign promises will again prove to be correct. I am a big believer in the idea that “nothing is ever as bad or good as it seems.”  The political grandstanding by both sides leading up to the election made every proposal feel like it will have sensational impacts.  Political changes do have investment impacts, but economics carry the markets forward at the end of the day. The bottom line is economies are in better shape than they were during the government-mandated shutdowns and look to still be on the path to recovery. As the prospects for additional vaccinations for those who want them come to fruition, life returns to "normal”, we could continue to see economic indicators improve.