By Gene Balas, CFA®
Investment Strategist
Context and background
The Biden Administration proposed its budget for the coming fiscal year, which begins October 1, 2022 and runs through September 30, 2023—the end of the federal government’s fiscal year.
Some of the agenda items in the budget are policy priority items, such as those contained in the ‘Build Back Better’ program, and the budget seeks to provide ways to fund those programs as well as reduce the federal budget deficit.
The 2023 budget calls for $1.598 trillion in so-called discretionary spending—areas that aren’t linked with mandatory programs like Social Security. Included in that total are $813 billion for defense-related programs, and $769 billion for domestic spending (along with other smaller items).
Aided by the elimination of pandemic assistance programs, the budget would reduce deficit spending by roughly $1 trillion over the coming decade (versus a baseline case), but with shortfalls averaging 4.7% of GDP over that period, the national debt in total dollars would continue to climb.
What is the ‘Billionaire Tax’?
The headline feature of the budget is a proposed new tax on American households worth more than $100 million, requiring those households to pay a rate of at least 20% on their income as well as any unrealized gains in the value of their liquid assets (including stocks), which currently are allowed to accumulate value for years and only taxed upon their sale.
The White House estimates the new tax would raise an additional $360 billion in revenue over the decade. (Of course, it’s important to note that estimating any future capital gains tax revenues requires many assumptions regarding future investment returns—always a difficult challenge, as anyone planning for retirement can attest.)
- This Billionaire Tax would apply only to those who don’t already pay a tax rate of at least 20% on their income and unrealized gains. Anyone who pays below that level would consequently be required to pay the difference between their current tax rate and the new 20% rate.
- The tax would apply only to the top one-hundredth of 1% of American households (with over half the revenue coming from those worth more than $1 billion). According to the New York Times, it would only impact around 20,000 households in total across the country.
A possible obstacle to this plan is that the 16th Amendment to the U.S. Constitution gives Congress “power to lay and collect taxes on incomes.” However, courts have previously struck down taxes on wealth (which is deemed assets on a household’s balance sheet rather than inflows on a household’s income statement).
However, by positioning this as a tax on a household’s increase in wealth—as opposed to as an explicit wealth tax such as the one proposed by Senator Elizabeth Warren of Massachusetts—it may help increase the chance of the tax passing muster with the Supreme Court.
But as pointed out by Jason Furman, a Harvard economist who served as chair of President Barack Obama’s Council of Economic Advisers, a wealth tax polls far more favorably with the public than a tax on income. Such public attitudes against concentrated wealth shouldn’t come as any surprise, considering that more than $5 trillion is held by Americans worth at least $1 billion, according to the most recent Bloomberg Billionaires Index. What’s more, the wealth of this exclusive group (more than 800 U.S. billionaires who are tracked by the index) has risen by $1.56 trillion since the beginning of 2020. And the vast majority of that increase is in the form of unrealized gains, Bloomberg reports.
Is the ‘Billionaire Tax’ the only means of increasing revenues in this budget?
While the Billionaire Tax seems far removed from the lives of most Americans, other tax proposals in the budget could reach closer to home. Less headline-grabbing are calls for other tax increases on the rich and corporations alike; proposals which actually would generate greater tax revenues than the more publicized Billionaire Tax.
- One proposal would revert the top individual income tax rate back to 39.6% from the reduced 37% rate which was part of the Trump administration’s 2017 Tax Cuts and Jobs Act. The rate would apply to unmarried individual taxpayers with incomes of $400,000 or more, and married individuals with incomes of $450,000 or more, according to Treasury officials.
- The Biden administration is also proposing to increase the corporate tax rate from 21% to 28%; a partial rollback of the corporate tax cut in the 2017 law. It’s unclear, however, whether a higher tax rate on corporations could theoretically discourage them from providing larger pay increases to their employees, or whether lower after-tax corporate profits may possibly mean lower investment returns for many Americans’ 401(k) plans invested in common stocks.
All told, these tax proposals amount to a $2.5 trillion tax increase over a decade—a much larger headline figure than the more publicized subcomponent of the Billionaire Tax, which would raise $360 billion over the coming decade, according to Bloomberg.
As noted above, these proposed tax rates on the wealthy and corporations are essentially a reversion back to their pre-2017 rates. Only the Billionaire Tax is truly new in concept—particularly in light of its intention to tax unrealized (as opposed to realized) capital gains.
Will any of the proposals be able to garner enough support in Congress to become law? Previous efforts to raise taxes on the wealthy and corporations have run into resistance from moderate Democrats, including Senator Joe Manchin of West Virginia and Senator Kristen Sinema of Arizona. And many critics will likely make a strong case that penalizing income in this manner could drastically disincentivize new business formation and entrepreneurialism.
Economic assumptions underpinning the budget projections
Key to all the above mentioned numbers are the seemingly mundane details of the economic projections used in creating the budget proposal. They effectively drive estimates of future tax revenues and government spending, yet garner little attention beyond economists. Notably, the White House economic projections for growth and budget deficits are somewhat more optimistic than expectations from the Federal Reserve:
- The White House pins real gross domestic product growth (an inflation-adjusted measure) at 2% or more for each year over the next decade. But the median economic projections from the Fed’s board of governors and the Fed’s district bank presidents project the longer-run U.S. growth pace at just 1.8%.
- Similarly, the budget forecasts GDP to expand 3.8% this year, compared to the Fed’s 2.8% estimate.
- The budget also assumes an unemployment rate of 3.9% for this year (just above current levels) and for it to generally remain between 3.6% and 3.8% over the next decade. This is just a bit above the historic low reached before the pandemic and well below the unemployment rate in many, if not most, years.
These assumptions directly pertain to the budget. For example, certain expense items, such as federal benefits (including Medicaid), could face significantly greater outlays if unemployment is higher than forecast. Similarly, since income tax revenues depend on how many people are earning an income, the budget relies on optimistic assumptions for lower unemployment to drive higher revenues and lower expenses.
As for borrowing costs, consider that the interest rate on three-month Treasury bills was penciled in at 0.2% this year—less than half the current 0.5% level. Likewise, ten-year Treasury yields were forecast at 2.1%. Recently, yields were around 2.4%. In response to clear signals of the Fed’s intention to tighten monetary policy, interest rates have been steadily grinding higher. And because interest payments on the federal debt are an expense item in the budget, if budgeted interest rates are too low then interest expenses could be much higher than forecast.
Bearing in mind the many caveats noted above, the budget anticipates that fiscal deficits would be above $1.1 trillion each year over the next decade, hitting $1.8 trillion in 2032. And the deficit as a share of GDP is forecast to average 4.7% over the next decade. That’s similar to 2019 levels, though well above the ratios enjoyed prior to 2017’s tax cuts (e.g., in 2015, the deficit was 2.4% of GDP).
Concluding thoughts
Budgets proposed by any administration—of either party—have always served as more of an outline of priorities, goals, and aspirations, rather than concrete financial statements. Having covered economics in over a decade of writing in the media, an annual exercise I always conduct is to examine the proposed budgets of various administrations.
Regardless of the administration, every single budget is founded on optimistic assumptions. And they all include policy ideas and proposals that are unlikely (at least in their original form) to ever make it past Congress. Perhaps, though, that’s not their intended purpose. By stating objectives in this fashion, a President can provide the public with a ‘wish list’ of administration goals and aspirations. Whether certain proposals please you or anger you, keep in mind that none of them are the law of the land until passed by Congress.
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