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A Crucial U.S. Election That is Likely to Deliver Vastly Different Policy Outcomes

April 24, 2024

A Crucial U.S. Election That is Likely to Deliver Vastly Different Policy Outcomes

April 24, 2024

Commentary
This year marks the 50th anniversary of the rematch between heavyweight boxers Muhammad Ali and Joe Frazier, billed as ‘Super Fight II’. It was the second of three legendary bouts, sandwiched between the ‘Fight of the Century’ and the ‘Thrilla in Manila.’ On November 5th, the nominees for president in the 2024 election, Joe Biden and Donald Trump, will go toe-to-toe again in hopes of winning a second term in office. Current polls compiled by RealClearPolitics give a slight edge to Trump nationally, as well as the lead in all seven battleground states that will ultimately decide the outcome. President Biden released his budget in mid-March1, providing a roadmap of his second-term ambitions. For Donald Trump, we have his first-term record as well as public remarks since leaving office. The differences in styles and policies between these two contenders imply vastly different impacts on—and risks for—the U.S. economy. We will examine below left jabs and right crosses arising from proposals on fiscal policy, trade, regulation and geopolitics.

Fiscal Policy Prospects

When it comes to fiscal policy, the differences between the two candidates and their respective parties are diametric. President Biden and the Democrats have no problem increasing both spending and taxes, relying on the latter more than restraining outlays to control the deficit. And spending priorities won’t be sacrificed for the sake of deficit reduction.

By contrast, former President Trump and the Republicans are inclined to cut taxes and constrain spending, with the latter being the main channel for budget control. And tax priorities trump deficit reduction.

Enacting legislation that emphasizes these stark policy differences requires the president’s party to also control Congress, an alignment that tends not to last for long. For example, the American Rescue Plan Act and the Inflation Reduction Act were passed during the Biden administration’s first two years when the Democrats controlled the House and Senate. No Republicans voted for these bills, although there was bipartisan support for the other two parts of Biden’s industrial policy trifecta: the Infrastructure Investment and Jobs Act along with the CHIPS and Science Act. During the Trump administration’s first two years when the Republicans controlled both congressional bodies, the Tax Cuts and Jobs Act was passed. No Democrats voted for this bill.

Despite their policy differences, the Trump administration left a legacy of bigger budget deficits owing to tax cuts and pandemic relief, and the Biden administration is leaving one as well, also owing to pandemic relief along with health care outlays and spending on industrial policies. During the past eight years of big deficits (through FY2024), debt held by the public nearly doubled from US$14.2 trillion (76% of GDP) to US$28.2 trillion (100%). Along with rising interest rates, this has caused net interest outlays to soar, estimated at US$870 billion this year and on track to top US$1 trillion in FY2026. To put this in perspective: this year, interest payments will top defense spending as an outlay; next year, they will also surpass non-defense discretionary spending. This will crimp fiscal policy flexibility for whomever wins the White House and whichever party controls the House and/or Senate.

Chart 1. United States Budget Deficit Projections ($ Trillions)

A bar chart showing yearly budget deficit projections for 2023 to 2033.

Source: BMO Economics, CBO.

On top of rising interest payments, policymakers will face a fiscal cliff in 2026. The tax reductions for individuals, estates, and unincorporated businesses that were part of the 2017 Tax Cuts and Jobs Act (TCJA) are set to expire at the end of 2025. The hit to after-tax incomes in 2026 is estimated at about US$290 billion, with more than US$200 billion owing to higher personal tax rates. To the extent the latter are reflected in higher withholding taxes to start the year, there could be as much as a 4 percentage-point headwind for annualized real GDP growth in 2026 Q1.

However, when the authors of the TCJA devised this sunset to pay for permanent corporate tax cuts (because of budget rules), they assumed eventual across-the-board personal tax hikes would be politically unpalatable. They were correct. After taking control last year, House Republicans introduced a bill to make expiring TCJA measures permanent. Presumably, if Trump becomes president and the GOP holds the House and wins the Senate, this legislation could be enacted. The CBO estimates that the total cost through FY2033 of extending expiring TCJA measures would add US$3.5 trillion to the cumulative deficit (see Chart 1).

President Biden intends to make the expiring tax measures permanent only for those making less than US$400,000, paying for the extension via, “additional reforms to ensure that wealthy people and big corporations pay their fair share”. These “additional reforms” weren’t detailed in the President’s 2025 budget, but it did propose to increase corporate taxes, such as raising the rate from 21% to 28% and lifting the excise tax on stock buybacks. Biden’s budget also raises taxes on the wealthy by introducing a 25% rate on billionaire’s unrealized income and lifting the top income bracket’s rate from 37% to 39.6% (not waiting until 2026).

“The Inflation Reduction Act tax credits have been in the Republicans’ crosshairs since day one.”

The President’s budget is the opening salvo in negotiations for the fiscal year starting October 1. Through FY2034, Biden’s budget has net tax increases of US$4.7 trillion, net spending increases of US$1.8 trillion, and net interest savings of US$0.4 trillion. This results in a US$3.3 trillion reduction in the 10-year cumulative deficit (compared to the Office of Management and Budget’s baseline), on the back of higher taxation of corporations and the wealthy. Given offsets from even further taxation, extending the remaining expiring TCJA measures for the under $400K crowd would presumably not add to the 10-year shortfall. However, for this budget proposal to have influence over the negotiations under a second Biden term, the Democrats would have to win back the House and retain the Senate.

The election outcome might also decide the fate of the Inflation Reduction Act, and the suite of tax credits that it provides for electric vehicles (EVs) and other clean energy technologies. The credits have been in the Republicans’ crosshairs since day one. Even if Trump wins but Congress stays divided, there are executive actions he could take to narrow the interpretation of the guidelines and repeal some credits. The Biden administration has taken a broad interpretation (such as in what Evs qualify for the credits), which the GOP argues is helping entities outside the U.S. (and North America). The broadness has combined with latent concerns that the credits could disappear if the GOP scores a triple win, causing a surge in applications and projected cost. The IRA was originally supposed to cost under US$400 billion, but recent estimates peg it at well over US$800 billion. We suspect even some Democrats lament the consequences of an uncapped tax credit program, no matter how noble.

Trading Places?

President Biden and Donald Trump have one thing in common over trade: they are both wary of other countries gaining an unfair advantage to the detriment of American workers. While Biden added few new tariffs in his first term, neither did he repeal many of Trump’s earlier measures. Moreover, he has restricted China’s ability to purchase advanced AI chips from U.S. companies for national security reasons.

Meantime, Trump is eager to get back in the ring on trade. From the first bell, he is proposing a 10% tariff on all goods entering the country, while also considering a duty of more than 60% on China’s products, including a 100% penalty on vehicles from Mexico if made by Chinese companies that set up shop there. Congress would be virtually powerless to block these jabs, as the president has almost full discretion to impose tariffs on a country deemed to have an unfair trade advantage over U.S. firms. Because of Trump’s initial trade war, the U.S. already imposes a 25% tariff on more than half of imports from China and a smaller 7.5% duty on many other goods. New tariffs would lift U.S. inflation, though a higher dollar (stemming from reduced U.S. demand for foreign products and currencies) could temper the effect. But the real economic harm would come from the inevitable retaliatory actions of trading partners, including allies, that could lead to a series of escalating duties and restrictions. The tit-for-tat moves would impede trade flows, disrupt supply chains, and boost business costs, resulting in higher inflation and weaker global growth.

Chart 2. United States Bilateral Goods Trade Balances (US$ Billions: Annual to 2023)
A line graph showing U.S. bilateral goods trade balances with Mexico, Canada, and China since 2004.

Source: BMO Economics, Haver Analytics, Census Bureau.

A Trump presidency could also pose a threat to the free trade agreement between the U.S., Mexico and Canada. Saber-rattling over the USMCA would harm business investment, especially for the two smaller nations, and impede North American economic growth. Both Canada and Mexico have seen their goods trade surplus with the U.S. widen since the deal took effect in July 2020. After China, Mexico runs the largest surplus with the U.S., one that is more than two times larger than Canada’s (see Chart 2). Each country could pull out of the USMCA after giving six months’ notice, though it is unclear whether congressional approval is required. The agreement also comes up for review in 2026, when each member must decide whether to renew it beyond the pre-set termination date of 2036.

Regulation and Geopolitics

A Trump White House would have a much lighter regulatory touch than the Biden administration. This might support near-term growth, though possibly at the expense of longer-term risks. Biden favours greater financial industry regulation and supports Basel III proposals that would compel large banks to hold more capital against potential losses. He also favours enforcement of competition policies for businesses, which could raise the bar on mergers and acquisitions. A strong supporter of clean energy initiatives, he recently announced a pause on LNG exports. By contrast, in his first term President Trump rolled back some financial industry regulations put in place after the financial crisis. Along with banks, the energy industry would likely benefit from a Trump win. He may even resurrect the Keystone XL pipeline, which would be a plus for Canada’s energy industry. Geopolitical tensions could rise if either winner takes a more confrontational approach with China on trade or Taiwan. Trump has threatened to pull the U.S. out of NATO, which could embolden Russia to take more aggressive military action in Eastern Europe.

Final Round

For the Federal Reserve, Trump’s pro-growth policies could make the Federal Open Market Committee a little less willing to ease policy. Chairman Jerome Powell’s job could also be on the line, fanning uncertainty. Trump appointed Powell in 2018 but says he would not reappoint him upon expiration of his term as chair in 2026.

Under a Biden victory, continued deficit spending would support near-term growth with a partial offset from tougher regulations. Under a Trump White House, a likely wider budget gap and lighter regulatory touch could provide an extra boost to growth, with some offset from increased protectionism.

Regardless of which fighter’s arm is raised on November 5, the risks for inflation and interest rates could tilt higher amid expansionary fiscal policies. That said, the other major bout on the card that night will determine control of Congress, and a still-divided legislative branch would temper budget shortfalls, while having less influence on trade and regulations.

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