What the US midterms mean for investors
With Election Day upon us, Morningstar director of policy research Aron Szapiro takes a close look at what could change for investors.
It seems every election we are told this one is the most important in our lifetime, but people might just believe it this cycle. Early polling shows far more interest in this election than is typical for midterms.
And that makes one thing clear. No matter what happens, the day after the election there will be a lot of heated rhetoric about what the results mean and probably some market jitters. A lot of this noise you should just ignore as an investor (although you will almost surely be interested as a citizen).
After all, some of us are old enough to remember a whole year and half ago, when the Department of Justice named Robert Mueller as special counsel, and the stock market dipped on the expectation that Congress would be too consumed with the scandal to pass anticipated tax cuts.
Anyone who overreacted to that bump in the road missed out. Equity markets kept climbing, and the president signed the Tax Cuts and Jobs Act of 2017 right before the close of the year.
In 2019, when the new Congress is sworn in, there will be more heated rhetoric regardless of the outcome. You may well agree with some of it, but no matter how many times you hear the phrase "constitutional crisis" (and I expect to hear it a lot), markets and the overall economy are not tied to day-to-day political machinations.
If Democrats take control of at least the House (as seems likely, but is far from certain), they will be able to engage in aggressive oversight of the president and Congress may impeach him, which only requires a simple majority vote of the House.
However, under any circumstances, it will be hard to find the votes to remove the president from office unless one of their investigations or the special counsel's turns up something to bring two thirds of the Senate along to vote to convict on any impeachment charges.
Keep in mind markets did more than fine during president Bill Clinton's impeachment, but not so great during Watergate, and those two examples exhaust our experience of impeachment proceedings and financial markets, as the modern stock market did not exist when Andrew Johnson was president.
The US Federal Reserve and SEC are largely removed from politicking
In the end, the government is a huge, complex entity, and much of it will continue doing what it does - predicting the weather, acquiring military hardware, maintaining national parks - regardless of the showdowns in the halls of Congress. Independent agencies like the Securities and Exchange Commission are even further removed from day-to-day politicking.
On the bright side, there are some potential positives for investors regardless of who wins, based on the parties' agendas. There are also some improvements we'd recommend to these agendas based on the policy research we have done lately.
Base case: Republicans
If Republicans hold power, expect more certainty on tax cuts and new benefits for investing.
If Republicans maintain control of both houses, it would probably lead to more tax cuts and Congress cementing the tax changes from last year's tax cuts, which are currently due to expire for individuals in 2025. The House has already passed such a permanent extension, so if they maintain control of both houses of Congress and the presidency, there would certainly be an effort among Republicans to get this through the Senate. (Not that such an extension is certain even with unified control of government; depending on the size of the caucus, one or two members could derail these efforts.)
That could help people plan for the long term, and due to the permanent decline in the number of people who could itemise deductions, should make donor advised funds and contributions to charity out of required minimum distributions from retirement funds more popular.
Republicans in the House have also passed legislation with a number of ideas for improving the tax benefits for investing, such as relaxing required minimum distribution rules, expanding the uses for retirement money to include expenses for children, and, most interestingly, adding an account called the Universal Savings Account.
The spirit behind these ideas--incentivising people to invest for their goals--is great, but instead of adding additional complexity with new account types or further expanding retirement accounts into all-purpose savings accounts, we have a simpler idea to help investors.
Follow Australia and others in simplifying tax
Let's join the rest of the world by simplifying taxation of mutual funds. (This would also obviate a lot of concerns with RMDs if people could convert their withdrawals to a regular taxable investing account without holding assets in taxable accounts being a huge hassle.)
With very few exceptions (like Australia), most countries exempt fund investors from capital gains (although not necessarily income), which makes investing in a fund much easier for ordinary people. Right now, we treat a fund investor as if he owns the individual stocks himself, which is not quite right since fund investors have no control of when these stocks are sold.
Adding insult to injury, during downturns, as other investors flee a fund, it may need to sell stocks, turn unrealised gains into realised gains, and then pass on a large tax bill to the remaining investors. Since many people invest through 401(k)s or IRAs only, these tax rules do not affect them, but the best way to make taxable investing more attracting would be to make it less confusing and predictable.
It looks like Republican priorities are to help people invest their savings. Letting people pay capital gains when they sell their shares in a fund (rather than when a fund needs to sell its shares) would go a long way toward achieving that goal.
Furthermore, this current taxation issue is mostly an issue of timing rather than of net taxes paid. So it would make things easier for ordinary people, and in the long run would still raise tax revenue from capital gains in investments.
Base case: Democrats
If Democrats take power, expect renewed interest in big retirement policy revamps.
If Democrats take the House, the incoming chairman of the powerful House Ways and Means Committee would be Rep. Richard Neal, D-Mass., who is one of the leading thinkers in Congress on retirement policy and who has proposed some big ideas recently.
At a minimum, we would expect that ideas with broad, bipartisan appeal such as allowing small employers to band together to offer retirement plans (multiple-employer plans) and making it easier for employers to offer lifetime income options in their 401(k) plans by making their obligations as a fiduciary clearer in selecting insurers would be much more likely to pass.
There are several other alterations that could be made to the US retirement system. While some of the more substantive changes may have a hard time finding enough support to become law, if Democrats take controlm the ideas indicate a serious interest from the likely chair of the most powerful committee in the House in rethinking our retirement system.
Morningstar supports expanding access to retirement plans to more people, and we think behavioural research has demonstrated how useful automatic enrollment is at helping people overcome inertia.
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Aron Szapiro is Morningstar director of policy research
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