Biden: Build Back Better or Going Bust?

18 September 2020

Presidential candidate Joe Biden’s economic program is taking shape. His plan to “Build Back Better” following the pandemic will involve higher levels of government spending and taxation. My intention is not to project the numerical impact on the nation’s public finances, as this is ably accomplished by Penn Wharton, the Committee for a Responsible Federal Budget (CRFB), the American Enterprise Institute, and others. I gratefully use their projections. My aim is to assess some of the issues confronting investors (and the electorate). In particular, under current circumstances, is the plan realistic? On the other hand, how credible are the claims of Republican Party critics that the Democrats’ return to “tax and spend” policies will cripple the economy, turning the United States into a socialist nation?

Tax Hikes: Who Will Pay?

The consensus amongst forecasters is that the proposed tax increases will total roughly $3.5 trillion over the next 10 years. To be sure, that’s a lot of money, but is it enough to turn the USA into a socialist nation (a term that’s never clearly defined)? Under the plan, government revenues will likely rise just under 2% of GDP. The Chart below illustrates the proposed hikes will leave the US tax burden amongst the OECD’s lowest, and considerably below European Union levels. By all means, debating the desirable level of taxation and government spending is appropriate during election campaigns. But, the United States is not on the road to socialism!

Who will bear this burden? Planned hikes in marginal corporate tax rates (from 21% to 28%) along with other measures will add nearly $1 trillion to the business sector’s tax bill — roughly 0.5% of GDP. The Chart below illustrates that even after these measures, American firms will be subjected to a relatively low tax burden. That said, I would prefer to keep marginal tax rates low, and close corporate tax loopholes, which could easily raises 1% of GDP. Nevertheless, the competitiveness of US businesses should not be harmed excessively. Lowering the health care costs paid by US firms would easily offset this impact (more on this later).

Critics of the Biden plan suggest planned increases in government spending will lead to higher taxes for America’s middle class. The following Chart illustrates this is false. The proposed tax increases will be paid fully by the most affluent 1% of US households.

Some suggest that excessive taxation of high-income earners will create important disincentives to work and innovate. To be sure, the marginal tax rate of this group may rise as much as 15%. Nevertheless, even following the imposition of the higher levies, the top US effective marginal tax rate (includes income, sales, and social security payments) will remain below the OECD average (next Chart). This may suggest the disincentives are not as worrisome as feared.

In addition to raising revenues to fund new government spending priorities, the Biden program aims to make the US tax system more fair. To be sure, US income taxation is highly progressive. Indeed, the top 10% of the population accounts for roughly 75% of Federal government income tax revenues (the top 1% contributes nearly 40%). However, the next Chart illustrates that while the progressivity of the US tax system improved steady after 1980, little further progress has occurred since 2005.

To be sure, one of the objectives of the Biden tax plan is to address America’s widening income gap (an unfavourable trend occurring throughout the world). The Chart below indicates the gain in income share of the top quintile — especially the top 5% — has come at the expense of the poor and middle class, e.g. the bottom 60% of the population.

Build Back Better: New Spending Priorities

The well-respected Penn-Wharton Budget Model estimates the Biden spending plans will cost $5.4 trillion over the next 10 years. The ambitious expenditure program aims to both boost the supply-side of the economy and reset key national spending priorities. In particular, education will receive the largest boost in spending: up $1.9 trillion in the period ahead.

Infrastructure will be the second largest beneficiary — adding $1.6 trillion. The World Economic Forum annually ranks the quality of each country’s infrastructure. The USA ranks 13th (out of 141 nations), but lags behind key European nations, e.g. Germany, France and United Kingdom at 8th, 9th, and 11th respeectively. However, Asian nations establish the target the United States should aim at. Singapore, Korea, and Japan rank 1st, 5th, and 6th respectively. Asia enjoys superiority across the board. All transportation subsectors — road, train, ports, air — outperform, as do their and electric and water utility sectors.

Climate-related investments will account for a large portion of the infrastructure outlays. The Chart above illustrates US carbon dioxide emissions have continued to rise during the past 30 years, in stark contrast to the 20% decline in the European Union. As a result of efficiency gains and a shift from coal to natural gas, American green-house gas emissions have begun to fall at last. However, the Chart shows the USA still lags Europe’s performance in recent years. In the future, efficiency gains will not be enough to achieve the aims of the Paris Climate Accord; a more radical change in direction is required (see my earlier blog for more on this topic “Climate Change and the 2020 Election”).

Health care reform — widening coverage and lowering costs — is another Biden priority. His plan aims to expand the Obama-Biden era Affordable Care Act, to introduce a public option to compete with private exchanges, to expand long-term care and mental health funding, to cut drug prices, and to reduce the Medicare retirement age. Unfortunately, the cost projections for these reforms vary widely. The Biden campaign, for instance, estimates net outlays of $750 billion by 2030. On the other hand, Penn-Wharton’s low estimate ($500 billion) does not include the ACA extension and the public option — the most expensive features. The CRFB, perhaps, offers the most comprehensive private assessment: $1.5 trillion (double the campaign’s estimate).

The CRFB’s forecasts a 10% increase in Federal government health-care spending. Meanwhile, the low-cost public option should lower premiums and out-of-pocket expenses for the privately insured. Businesses may cut health care costs, as workers transition from employer-sponsored plans to the cheaper public option. While private sector cost reductions are difficult to project, the CRFB estimates overall national health expenditures may remain roughly stable over the next decade (expenses transfering from the private to public sector). If that happens (I have serious doubts), US bloated health-care expenditures (as a percent of GDP) would decline towards the upper end of the OECD range (12% of GDP).

Pulling the Pieces Together: Facing Future Challenges

  • The next Administration will inherit a sobering fiscal situation, which is likely to limit the government’s options, regardless of the election’s outcome. The non-partisan Congressional Budget Office (CBO) projects the US federal government deficit to reach 16% of GDP in 2020, and to remain at 9% of GDP next year. Even before considering the impact of either candidates’ expansive budgetary plans, the CBO estimates the red ink will average nearly 5% of GDP annually through 2030. As a result, Federal goverment debt will rise from 80% to nearly 110% of GDP between 2019 and 2030. The US fiscal situation is on an unstable trajectory.
  • Nevertheless, providing Covid-related financial support to the health care system, workers, and businesses must remain the priority in the near term. The CBO projections do not incorporate the likely need for considerable additional pandemic funding this winter.
  • The Biden economic program will hike taxes $3.5 trillion in the next 10 years, roughly 1.5% of GDP. As the Penn-Wharton model likely under-estimates the cost of proposed health care reforms, the Biden spending bill is likely to exceed $6 trillion (compared to the PW estimate of $5.4 trillion). As a result, this ambitious agenda may boost the Federal government deficit by an additional 0.5%-0.75% of GDP compared to the CBO’s baseline.
  • I project the Biden plan will not greatly alter the nation’s long-term GDP growth trajectory: the disincentives and drag from tax hikes will be offset by the boost from fiscal expansion and supply-side gains from spending on education and infrastructure.
  • Under Joe Biden, the US tax system would become more progressive — a welcome resumption of the long term trend in this direction.
  • The US corporate tax bill will initially rise 0.5% of GDP, but will remain amongst the world’s lowest. Moreover, lower healthcare costs may potentially offset this impact over the long term. Rather than hiking marginal tax rates, I would have prefered an end to generous corporate tax breaks (but, I was not asked!).
  • Despite claims to the contrary, Joe Biden is not a socialist! The USA will remain a low-tax nation compared to the rest of the world. As a result, I do not expect an exodus of talent, innovation, or businesses to result from the Biden economic strategy.
  • The Biden health care reforms are projected to half the number of uninsured toward 15 million people (compared to 50 million prior to the ACA’s enactment). The plan will lead to an increasing government role in the health care system: already roughly 60% of the insured are covered by public sector programs. I am always disappointed that reforms rely overly on tax increases, rather than curbing the system’s exorbitant cost structure. The Biden plan is no different. Two-thirds of the cost of expanding health care coverage falls on higher taxation. I am not optimistic that health care costs will decline much below 14-15% of GDP in the next decade (the world’s highest).
  • Fiscal reality may eventually curb Joe Biden’s ambitious spending agenda. I estimate that simply stabilising — not reducing — the US public sector debt ratio will require belt-tightening measures of at least 2% of GDP, as opposed to the proposed expansion. Maintaining the planned spending plan could require additional tax hikes. While Biden would hope not to increase middle-class taxes, the burden surely will spread beyond the top 1%.
  • Financial markets will focus on whether Joe Biden’s selection of Treasury Secretary comes from the progressive end of the Democratic spectrum.
  • To be sure, the Biden program is ambitious, expensive; addressing the key issues of health care, climate change, infrastructure, and inequality. To a degree, it’s transparent enough to be scrutinized and costed. We look forward to hearing President Trump’s priorities for a second term.