President Biden’s proposed $1.8 trillion American Families Plan on top of his $2.3 trillion American Jobs Plan and his $1.9 trillion American Rescue Plan together make the biggest increase in government spending since the big Roosevelt increases. Like the Roosevelt New Deal, the Biden plan is a bold move to radically reform and redistribute wealth and opportunities and to stimulate the economy. 

The Big Picture: Where We Are in the Big Left-Right Cycle

What’s happening is classic and cyclical—i.e., we are seeing the left-right pendulum that has big swings back and forth between 1) more government, more redistributions of wealth and income, and less fiscal and monetary discipline, and 2) less government and fewer redistributions of wealth and income swing sharply to policies of type 1) (left) from policies of type 2) (right) for logical reasons that have timelessly and universally caused these swings. To put where we are in the cycle in perspective by looking at where we have come from over the last 100 years, that cycle has transpired as follows:

• The peak in the policies of the right occurred in 1929-32 when...
• ...in 1932 there was a big cycle swing to the left (when Roosevelt and the Democrats came in) that continued until around 1980 when it peaked and...
• ...there was the big cycle swing to the right (when Reagan and the Republicans came in), which continued until 2020 when it peaked and...
• ...there was the big cycle swing to the left (when Biden and the Democrats came in). 
• By the way these presidents didn’t lead the changes as much as they were chosen by people who changed their approaches as they reacted to the consequences of the excesses of the swings.  

The chart below shows one of the reflections of the big left-right cycle I referred to before—i.e., rising taxes reflect more policies of the left and falling taxes reflect more policies of the right. As shown we estimate that passing the Biden plan as proposed would lead to a 4-6% increase in lifetime tax paid (green dot) for the richest Americans. We estimate that in their lifetimes these taxes would take a bit more than half of their wealth. This isn’t an expert assessment (since we’re not tax experts)—this is us creating quick, rough estimates with simplifying assumptions for the purposes of our research. And naturally, there is no precision to the exercise.

More specifically, this is how the big cycle transpired:

1. The right/capitalist Roaring ’20s created lots of debt, speculative bubbles, and large wealth gaps, which led to
2. a debt and shortage of money crisis that led to the Great Depression, which combined with the big wealth gaps led to
3. the big move to the left with the Roosevelt plan, which produced big increases in government spending on programs to reform and redistribute wealth and opportunities and to stimulate the economy via the creation of a lot of debt, the devaluation of money (i.e., the going off the gold standard), and big increases in taxes. 
4. Then the financial strains across the world and the rising of Germany and Japan as world powers led to the war, which necessitated the creation of a lot more debt and debt monetization by all countries in the war, which reduced the wealth gap within countries and left the US the richest and most powerful country in the world, the UK overly indebted, and Germany and Japan broke and broken, which led to
5. the new and American world order with the US dollar being the leading reserve currency and the decline of Britain and the British pound, while
6. the policies of the left (e.g., large government expenditures, large redistributions of wealth via high taxes, large deficits, large printing of money) continued and led to
7. a debt crisis and money shortage that led to the going off the gold standard under Nixon and much greater debt and money creation, which led to
8. terrible inflation, big government debts, inefficiencies, and strong unions that in 1979-81 led to
9. the big swing to the right via the elections of Margaret Thatcher in the UK, Ronald Reagan in the US, and, soon after, Helmut Kohl in Germany. 1979-81 was the big cycle peak of policies of the left and the swing to classic policies of the right, which became overdone and led to
10. the shift to classic policies of the left in the form of what we are now seeing in the Biden policies and the Fed policies, which are analogous to those in the 1930s. These policies will likely be important defining influences of the new paradigm that we will be in for the next several years. 

Of course, not everything is the same now as it was in the early Roosevelt years so one can rightly say this and that are different, but that wouldn’t change the fact that a) this big cycle by and large exists for by and large the same reasons it has always existed so b) it is important to keep it in mind and to know where we are in it, c) we are now moving from peak policies of the right (capitalism) to those that you can see for yourself by watching what is going on with fiscal and monetary policy, and d) this is happening for all the classic reasons.  

More specifically:

Big increases in spending will be partially funded by big increases in taxes (especially on companies and the rich) and partially funded by large increases in debt that has to be sold to a) investors who already hold too much of it and are disincentivized to buy it by the low real interest rates, and b) the Fed, which probably will be incentivized to buy enough of it to prevent an interest rate rise that would be too painful to bear. The most likely effects will be higher inflation and a declining dollar relative to other assets, perhaps in tolerable degrees and perhaps in intolerable degrees (depending on how the supply/demand picture for dollar debt changes—i.e., whether there is selling of dollar debt, which would require greater debt monetization).

The combined other effects are too tough for me and us to gauge without a lot more work—e.g., the increases in corporate taxes, capital gains taxes, and the removal of stepped-up basis for estates together are negative for stocks, while the massive fiscal stimulation and debt monetization are positive. Also, while these programs could have big beneficial effects on productivity over the long term (e.g., through improving infrastructure and public education), how well that goes will depend a lot on how efficiently these programs are built and administered, and governments do not have a great track record of building and administering programs efficiently. Said another way, a) the Biden tax and spend proposals together are a big gamble that the Democrats had to make now within their window of opportunity in order to have a revolutionary big impact as soon as possible, and b) I can’t tell you exactly how this will shake out. To be clear, to not have made the bet probably would have been as risky as to have made it because the consequences of the lack of reforms are also very dangerous.  

Unfortunately and unsurprisingly, most reactions to the plan have been either extremely negative or extremely positive based solely on the biases of people who are either net gaining or net losing from the plan. I try to be more like a mechanic than an ideologue, simply trying to see the implications for what will happen in the economy and markets and hoping for what produces the most prosperity for the most people. Frankly, I don’t care what plan we have as long as 1) we collectively accept it so it doesn’t tear us apart, 2) it raises living standards (e.g., increases productivity), and 3) it benefits most of the people. As you know from reading my piece “Why and How Capitalism Needs to Be Reformed" and my series “The Changing World Order,” while I believe that the capitalist profit-making system is the best system for increasing the size of the pie, it has not been good enough in dividing the pie well. That is because of how the economic machine works, and not because of capitalists being evil. For example the pursuit of profits and cost efficiencies (e.g., via using technologies and foreign workers as substitutes for domestic workers, and by incentivizing entrepreneurial inventors of new technologies) tends to produce gaps in wealth, opportunities, politics, and education levels and, repeatedly throughout history, those societies that a) have large gaps in wealth, opportunities, and politics, b) don’t broadly educate their populations in skills and civility, and c) have bad financial and economic circumstances are likely to have big and disruptive internal conflicts (e.g., civil wars and revolutions). We have also seen that if these happen at the same time as d) the country is being challenged by a strong external power (e.g., China) that requires more military spending and conflicts that produce more big financial and other stresses. Experiencing this confluence of forces typically leads to damaging conflicts and painful declines. My views have also been affected by what I (and my wife) have seen happening to children living in poverty and attending underfunded schools, some of whom turn into unemployable adults. To not fund the rectification of that situation is morally vacuous and economically stupid. Because to me not having connectivity in 2021 is like not having a telephone 50 years ago, it prevents productive interactions and learning, I like the part of the Biden plan that will rectify that. For similar reasons I like free early childhood education, free lunches for students in poor neighborhoods, free access to community college, and infrastructure improvements. I believe that they are smart investments that will financially return more than they cost and will make for a better and more equal opportunity society IF implemented well. There are other aspects of the program that I like and parts that I question. At the same time I am, as of now, incapable of telling you how all of these things will net out. I believe that no one can now tell you how they will net out, which is why I believe it’s a big gamble.  

A More Close-Up Look at the Plan

In the remainder of today’s Observations, we very roughly pencil out the magnitude of the tax changes, look at roughly what tax rates will be on different tiers of wealth/income compared to history, and also look very briefly at the new programs Biden is proposing. This is the quick summary of our scan of the tax package:

• Absent extraordinary efforts to evade the tax, the Biden tax package (as proposed) would probably be the largest single tax increase on the wealthy since FDR. We did an exercise of modeling the taxes people would face over the course of their lifetimes. While there is no precision to the exercise, we roughly estimate that Biden’s plan, as proposed, would represent a roughly 4-6% tax rate increase or a 10% or so decline in after-tax lifetime earnings (including regular income and returns on assets). That is represented in the chart we showed earlier.
• Still, those taxed most heavily, the ultra-wealthy, will face lower tax rates than they did at the height of tax burdens in the 1960s and 1970s. Since that period, the ultra-rich have had their effective tax rates decline over time as the average American has seen their taxes stay flat or even slightly rise. Biden is reversing a portion of that decline.

Importantly, even as overall tax rates have been falling on the top-earning households through time, their overall share of taxes (as a percent of income taxes the federal government receives from households) has increased. This is largely a function of increased concentration of wealth and income at the top. The chart below attributes the income taxes the government receives by the top 10%, the bottom 90%, and corporate income taxes.

The chart below compares our rough estimate of the Biden tax plan to several of the largest prior increases in effective tax rates. As you can see, by our rough estimates, Biden’s tax increase is the biggest since Roosevelt’s tax increases (shown below are Roosevelt’s “Soak the Rich” plan in 1935 and his WWII tax increase).

The new taxes are being used to finance a number of new social programs, tax credits, expansions in government services, etc. At first blush they strike us as smart investments in infrastructure, education, and expansions of the social safety net. However, we have to look into these programs much more carefully to figure out how well they will both increase the size of the pie by raising productivity as well as how much better they will divide the pie. This chart shows the areas of new spending in Biden’s infrastructure and American Families plans (using the New York Times’ classification of spending areas).

Below, we show the eight biggest programs in the American Families Plan.

Below these are many, many programs that will be doled out in many, many ways and in many locations. How efficiently or wastefully spent this will be, we honestly can’t say yet.

Appendix: A More Detailed Look at the Tax Proposal

Biden’s tax package includes changes to capital gains taxes and income taxes. The following table summarizes where some key taxes stand now and the changes being pursued. Note: we are awaiting the final details of the plan, and we will revisit when we have the specifics for the proposed provisions from the Treasury in conjunction with the release of Biden’s budget (expected in May).

To go into more detail on some of the major provisions:

• Biden proposed to undo the 2017 TCJA/Trump tax cuts for high-income filers by having the top marginal personal income tax rate revert back to 39.6% from 37% and is expected to reinstitute a limitation on itemized deductions. Importantly, it generates no long-term revenue (beyond 2026) to pay for permanent government spending increases as required under Senate reconciliation rules.
• Biden proposed to tax long-term capital gains and qualified dividends at the same rate as ordinary income for income above $1 million (or 39.6%, per his plan). The capital gains/qualified dividends rate will top out at 43.4% (versus 23.8% today) as it retains the 3.8% net investment tax that helps fund the Affordable Care Act (aka Obamacare). Biden wants to apply the Obamacare surtax of 3.8% to all business income received by an individual on income over $400,000 a year.
• Significantly, Biden also proposes to repeal step-up in basis at death—to force realization of capital gains at death. Biden is proposing that for joint estates, the first $2 million in capital gains will be exempt, and so will the first $500,000 of capital gains on one’s primary residence. Note that a top rate in the range of 28-30% with the 3.8% Obamacare surtax (for an effective rate of 31.8-33.8%) and carryover of basis is a possible compromise. A 28% rate is where the tax was set in the Reagan years. Net assets, more than the exemption amount, would still be subject to the estate tax.
• Biden also proposed the repeal of Section 1031 “like-kind” exchanges for real estate owners/investors for gains above $500,000. The 1031 exchanges allow investors to defer capital gains taxes due upon the sale of a real property by reinvesting the proceeds into another “like-kind” property of equal or higher value.
• A number of smaller provisions are included as well, including some exemptions for family-owned businesses/farms from the capital gains tax at death (if the beneficiaries intend to continue the business), repeal of the preferential treatment of carried interest, and making loss limitation on pass-through entities permanent (which would prevent many business owners from showing no income and paying no income taxes).
• Rigorous tax law enforcement by the IRS is another measure advanced by Biden. Biden proposes to increase funding by $80 billion over 10 years in order to capture $700 billion over 10 years of uncollected taxes. Democrats in the past have estimated that in excess of $300 billion a year in taxes due are not collected, primarily due to lax enforcement. The IRS commissioner recently put that figure at $1 trillion. The Congressional Budget Office estimates, however, that every $40 billion increase in IRS funding will bring in $100 billion over 10 years. This is in large part explained by taxes lost in cash transactions.

How Will These Changes Impact the Taxes People Face Over the Course of Their Lives?

To assess how much these tax changes will actually translate into higher taxes paid over a full lifetime, we built a rough model. We looked at the typical path of a person’s life—earning years, retirement, and death—and calculated taxes on earnings/asset returns at the point they were earned, and taxes at the point they were paid, to get a lifetime taxation picture. Again, we can’t be sure they are precisely right since we’re not tax experts, but they are probably approximately right.

We’ll start by showing taxes under current laws (i.e., before Biden’s changes). Below, we start by looking at the major taxes by wealth and income percentile. The first table shows lifetime average “effective tax rates” under current tax laws in the common terms people think of them—income tax as a percent of income, sales tax as a percent of spending, etc.

Some interesting things to note:

• Of course, the rich pay more taxes in aggregate. But looking at data on the taxes people actually pay (e.g., after deductions[1]), the rates are less different once taxpayers are past the top 10% level.
• You can see that payroll taxes in the current regime are regressive—these phase out after a certain amount of income.

In order to show a more apples-to-apples comparison across the tax rates, the table below shows our rough estimates of all of the taxes relative to the total money a person makes in their life (income plus returns from assets) under current laws. Here, we can see how much each tax contributes to the overall tax burden a household faces across all the money they’ve earned in their life.

When we run the Biden plan through the same process, we get a roughly 4-6% increase of tax rates on the top 0.01%, a decline in after-tax income of 10%, give or take. For the bottom, taxes paid will be largely unchanged (though they will be receiving new benefits and tax credits). 

Tax Burden Through Time and Comparing Biden’s Tax Plan to Historical Ones

To put Biden’s changes into context, below we look at rough estimates of effective tax rates through around a century of US history. Biden’s plan reverses some of the decline in tax rates paid by the top that we’ve seen over the last 40 years, but those tax rates still will be well below the 1960s-70s highs.

While the overall tax burden on the wealthiest households has been on the decline, the tax burden has remained relatively constant for average households. This has come through a combination of the changes to the estate tax, decreases in the highest marginal tax rate, and reductions in business income taxes. These are taxes that don’t impact the average households much, so the benefits have accrued for the top households. Lower-income households have also been hurt by the regressive nature of payroll taxes.

Meanwhile, the last large shift we saw in tax burdens was from the Great Depression through about 1950 or 1960. The tax increase was broadly paid for by households throughout the wealth and income spectrum and in part came as a result of needing money to fund the high tax burdens of WWII. A couple of the major changes to tax policy during this time were:

• Federal tax rates rose through the Great Depression and WWII. The top tax rate was 25% prior to the Great Depression and peaked at 94% during WWII for anyone with an income over $200,000 (~$3 million in today’s dollars).
• The top estate tax rate rose from 20% in the early 1930s to 77% in the early 1940s, in large part due to FDR’s “Soak the Rich” tax legislation.
• Corporate tax rates increased, especially through the Revenue Acts of 1940, 1941, and 1942, which in total took tax rates from 19% to 40%.

Now that we know the numbers, our work begins to figure out how these changes will affect the flows of money and credit and in turn the markets and the economy.  

[1] Another significant reason that the income taxes paid by the wealthier aren’t much higher is that currently much of it comes in as private business earnings (e.g., partnerships or S-corps), which come with a much lower tax rate. Biden is aiming to close this discrepancy.

https://www.linkedin.com/pulse/biden-tax-spend-plan-big-cycle-swing-ray-dalio/