Super Tuesday Kicks Off Another American Tax Debate

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Today is Super Tuesday, and that can only mean one thing—well, one thing on top of the pending relief from incessant political ads in the 15 states voting today. That thing? The general election is coming into sharper focus, and—barring something out of left field happening—a November rematch between Presidents Joe Biden and Donald Trump. As usual, much of the focus is on talk and personalities, which we always encourage investors to tune out—markets care about policies and legislative risk, not rhetoric and partisan affiliation. But some of the chatter is now turning to actual policies—specifically, taxes, and the fact that policy is up for grabs on that front. In our view, this is a ripe area for uncertainty to fall gradually, which should help stocks regardless of how Congress approaches the issue.

The central issue here is 2017’s Tax Cuts and Jobs Act (TCJA), which—on the individual side—did each of the following things:

• Reduced the number of tax brackets
• Cut the top marginal rate from 39.6% to 37.0%
• Lowered the income tax band thresholds
• Patched the Alternative Minimum Tax (AMT) so that it ensnared fewer people
• Raised the exemption for estate taxes
• Eased the burden on self-employed people who receive “pass though” income from their business
• Capped the state and local tax (SALT) deduction
• And scrapped many other itemized deductions in favor of doubling the standard deduction.

The result was a small tax cut for most American households, and politicians have been squabbling about the scope and economic impact ever since.

Like most US tax changes in recent decades, these measures weren’t permanent. Congress’s rules allow permanent revenue reductions passed by a simple majority only if they don’t increase the deficit beyond 10 years, so lawmakers get around this by making partisan tax cuts sunset after a decade. This then sets up big freakouts over “fiscal cliffs” as the expiration date approaches, which usually ends up with the prior cuts getting extended at least in part, which is how the Bush II tax cuts became the Obama tax cuts.

We are now nearing this point with the TCJA, whose individual cuts expire after 2025. If Congress lets this happen, America will revert to the pre-2017 status quo, including more tax brackets, a higher top marginal rate, more deductions, a lower standard deduction and no SALT cap. A lot of people will probably cheer the latter, considering Congress has been trying to raise or eliminate it for some households for a couple years. But the rest don’t bring much cheer, because no one likes higher taxes. It also brings zero clarity, since reverting to the status quo means applying the old system’s inflation adjustments to the tax band thresholds. Meaning, applying nearly a decade’s worth of adjustments. That is a lot of math and a big unknown, especially with two years left.

So talk is simmering, and as the election approaches, pundits are starting to parse Biden and Trump’s tax talk for clues as to how this will pan out. We saw a lengthy discussion of this in The New York Times this week, and it isn’t alone. Look, we understand, but we think it is fruitless and premature to spend so much time weighing. Congress, not the president, holds the power of the purse. The president can suggest legislation and can sign or veto whatever Congress passes, but the details of any future tax policy depend on whatever the House and Senate concoct and compromise on. This will depend on this year’s Congressional elections, which presently look set to extend gridlock, which probably means a lot of tax squabbling over the next couple of years.

Which in turn means uncertainty will linger, especially if they take their usual tack and run out the clock—or miss the deadline entirely and pass something retroactive at some point in 2026. However it pans out, we suspect markets will take it in stride as usual, slowly pricing in all potential scenarios as the discussion and proposals percolate, perhaps with some volatility as and when politicians decide it is necessary to amp up fiscal cliff warnings. But in the end, we probably won’t get more than a few tweaks here and there, not enough to move the needle in either direction, and not out of sync with how taxes have moved over the past few decades. Anything sweeping seems unlikely if the House and Senate emerge from November as divided as looks possible today.

Small changes at the tax code’s margins likely won’t sway markets much. The TCJA wasn’t exactly mega-bullish—even if you factor in the corporate income tax cut from 35% to 21%. The bull market that existed pre-TCJA extended post-TCJA. Maybe it helped returns in 2017 somewhat. Maybe it pulled returns forward from 2018, contributing to a mild decline that year and netting to nothingness. But those points can’t be proven clearly. What can is that the TCJA didn’t shift cycles from bull to bear or bear to bull. It was too incremental and too widely known.

That example illustrates a broader point: Tax changes have no pre-set relationship with stocks. The 2001 tax cuts didn’t end the bear market that ran from 2000 to 2002. 2003’s came early in a bull market. The Obama administration raising the top bracket rate at 2012’s close and slapping a 3.8% investment income surtax didn’t stop the 2009 – 2020 bull market. We won’t bore you with the full history here. But understand: Cuts aren’t bullish or bearish, and hikes aren’t bearish or bullish. Taxes are just one variable that affect disposable income and how money flows in general—and not a huge one.

Ordinarily, we might argue uncertainty would delay risk-taking as people and companies wait and see what the new rules are before they deploy investments. The thing is, the US tax code is always in flux. Everyone knows it! Tax policy passed along partisan lines is easily changed by a future Congress whether or not prior cuts are about to expire. Politicians love tweaking rates at the margins to make a point or buy votes, and America has mostly adapted to see this uncertainty as the cost of doing business, background noise. Mostly, we see the pending tax debate as something with the potential to affect sentiment as politicians and headlines whip up a frenzy, and the more clarity we get, the more that effect should wane.