Wed, Oct 2, 2024

Assessing the Economic Impact on Businesses Post-Election

From tax policy and regulation to spending priorities and international trade, the candidates in the U.S. presidential election, and to a greater or lesser extent in this year’s wave of elections in the UK, France, India and elsewhere around the world, have espoused widely divergent policy directions with potentially significant implications for the economy. As the U.S. election unfolds, Kroll assesses the potential impact on businesses across key aspects of economic policy.

Federal Budget Deficit vs. Debt: Where We Stand?

The lure of increased federal/national government spending to stimulate the economy or certain sectors is strong across the political spectrum, even though spending priorities, whether in defense, infrastructure, health care, education or social programs, may vary greatly. While high levels of government spending can have a stimulative effect, particularly in the short-term, it can also add to the government’s budget deficit. This is particularly problematic for countries that are still grappling with the heavy fiscal burden created by programs implemented in response to COVID-19.

Rising federal government debt is the elephant in the room as the U.S. debt burden is growing at an unsustainable pace. According to the latest analysis by the non-partisan Congressional Budget Office, interest expense on federal debt is expected to reach 3.4% of GDP in 2025, exceeding most other federal budget categories, including defense, Medicare and Medicaid mandatory spending. This analysis reflects current law, without taking into account the impact of further fiscal spending promised during the presidential campaign trail.1

Recent analysis by the independent Penn Wharton Budget Model of the spending and tax plans of the presidential candidates shows that both plans would add significantly to the deficit over the next 10 years.2 That equation is further complicated by uncertainty over the fate of the Tax Cuts and Jobs Act of 2017 (TCJA) as certain temporary tax cut provisions are set to expire in 2025. By some estimates, making those provisions permanent would add in excess of $4 trillion over the next 10 years to the national debt. On the other hand, not extending some of the provisions may weigh on consumer spending in the near to medium term, as disposable income would decline for some income echelons.

Promises that higher spending or tax cuts will stimulate the economy creating a fiscal multiplier effect that will offset the deficit impact are not borne out by research or the historical record. Politicians often believe that the increase in economic growth will create tax revenues that will far outweigh the extra fiscal spending, which is not what typically has happened. If investors doubt the credibility of such promises, it can lead to financial market turmoil. The UK experience in 2022 offers a cautionary tale. Shortly after taking office, the government of Prime Minister Liz Truss proposed a significant tax cut, including reductions in top income tax rates, claiming that lowering the top rates would more than pay for themselves by boosting economic growth. Financial markets, already reeling from the economic shock of the war in Ukraine, responded with a massive sell-off of UK government bonds that sent interest rates soaring and the British pound plunging in value. The Truss government quickly backtracked but the damage was done and contributed to her resignation shortly thereafter after just 49 days as Prime Minister—the shortest term in UK history. More recently, the International Monetary Fund (IMF) has been sounding the alarm on the dangers of large fiscal deficits and elevated debt levels, which have been on an upward trajectory across the globe, calling for fiscal prudence.3

For businesses, the impact of higher government debt burden is most directly felt in its impact on interest rates. In the U.S., expectations are that the U.S. Federal Reserve, which had raised interest rates to a 20-year high as it tried to rein in inflation, will make several interest rate cuts in the coming months. However, in the longer term, the unsustainability of a high government debt burden is likely to exert upward pressure on interest rates and debt yields. This can impact virtually all sectors of the economy by raising the cost of capital, pressuring valuations and balance sheets, inhibiting M&A and private equity activity, and leading to delayed or deferred capital investment.

For businesses, the impact of a higher government debt burden is most directly felt in its impact on interest rates... in the longer term, the unsustainability of a high government debt burden is likely to exert upward pressure on interest rates and debt yields.

Economic Implications of Corporate Tax Changes

Tax policies affect economic activity and influence business behavior. While small changes in tax rates or policies generally have limited impact as businesses can usually quickly adapt, big changes can impact valuations and the public markets, as well as business investment and capital allocation decisions. The TCJA permanently reduced the corporate tax rate from 35% to 21% and the current U.S. Presidential candidates have announced widely divergent views on future tax rates. The Trump campaign is vowing to reduce the rate further to 15% while the Harris campaign has pledged to raise the rate to 28%. However, statutory tax rates are just one part of the corporate tax story. The effective tax rate that companies actually pay may be substantially different from the statutory tax rate as a result of tax credits and benefits and the tax treatment of various expenditures.

Targeted tax benefits or credits can boost certain sectors, while removing or altering them can significantly change the outlook and attractiveness of those sectors. As just one example, the Inflation Reduction Act of 2022 (IRA) includes significant business tax credits, deductions and incentives for investment in clean and alternative energy, resulting in a significant boost in valuation for many clean energy-focused companies and sectors. Depending on the election outcome, we could see a rollback of some of the IRA’s provisions under a Trump administration or cementing of existing policies under a Harris administration.

Import tariffs are another element of tax policy that can have a significant impact on business, particularly companies or sectors with a heavy reliance on imported components or products. While both the previous and current administrations have shown a willingness to make greater use of tariffs, particularly with regard to China, the Trump campaign announced a plan for a tariff of 10% to 20% on all imports and a 60% or more tariff on imports from China. If implemented, it would represent the most significant change in U.S. tariff policy in decades. Economists are often opposed to policies entailing large tariffs, as they tend to lead to retaliation by trading partners, a retrenchment in global trade and ultimately higher prices for consumers.

The Ripple Effect of Regulatory Changes

Given a choice, businesses generally favor less regulation than more, but what they dislike most is uncertainty because it makes it difficult, if not impossible, to plan, manage, or make strategic decisions. An uncertain election outcome between candidates with widely divergent policies and approaches on regulation, coupled with the uncertain impact of recent court decisions—especially the Supreme Court’s recent overruling of the “Chevron” doctrine, which limits the ability of administrative agencies to interpret regulations—has created uncertainty around both current and future regulation, with potentially profound implications for business.

That uncertainty can already be seen playing out in the rapidly emerging AI sector. While concerns over return on the massive investments being made has already roiled equity markets in 2024, regulation remains another important wild card as regulators and elected officials in the U.S. and around the world weigh AI’s potential productivity gains and economic benefits against safety, privacy and bias concerns.

The political stakes in elections are often self-evident. The economic stakes for businesses and consumers, while less certain, can be just as high. The outcome of the U.S. elections may result in significant ramifications to the rest of the world.

 

Sources
1 “An Update to the Budget and Economic Outlook: 2024 to 2034”, Congressional Budget Office, June 2024.
2 Analysis as of August 26, 2024, which does not take into account any more recent proposals that may be introduced during the campaign period leading up to election day on November 5, 2024. For the latest analyses, visit: https://budgetmodel.wharton.upenn.edu/.
3 “Political Parties of all Stripes are Pushing for Higher Government Spending”, IMF Blog, September 16, 2024.

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