Chapter One: Investing and Planning Scenarios
The 2016 presidential election is like nothing most Americans have seen in U.S. politics. Hillary Clinton and Donald Trump have very different views on where the U.S. should be led, and more specifically, how we will arrive there. The following is the first chapter of what is likely to be many on policy proposal developments from each candidate, and how they may impact investment and financial planning strategies.
Taxes are one of the biggest platform topics being addressed this year. Depending on the outcome, the policies can directly influence investment and financial planning strategies. Each candidate approaches the tax issue from very a different perspective. Where Clinton seeks to raise taxes on the highest earners, Trump looks to reduce taxes across the board, albeit with the largest benefit going to the highest earners. Experts believe each plan has economic consequences. Under Clinton’s plan, increasing taxes on the wealthiest may be appealing to the 95% that will see no change, but it is also expected to negatively impact U.S. GDP by 1% annually over ten years.
Trump’s plan seeks to lower taxes on individuals and businesses, which could help increase economic growth, but at the same time dramatically increases U.S. debt. Such an outcome may increase the cost of U.S. borrowing and translate into higher borrowing costs for businesses, ultimately slowing economic growth. The following are some larger points from each candidate’s proposal, followed by our thoughts on investment opportunities and risks:
Clinton on Taxes: Clinton is focused on levying higher taxes on the highest earners in the U.S. through surcharges, minimum taxes, and limits to deductions and exclusions. Her proposal targets foreign profits and encourages longer investment horizons by making the current long-term capital gains rate only available after six years.
- 4% surcharge on individuals earning more than $5 million per year.
- 30% minimum tax on those earning more than $1 million.
- Limit deductions and exclusions to 28%.
- Change the structure of capital gains tax to allow for a declining rate for longer hold periods. Investments held six years or longer can receive the 23.8% tax rate.
- Limit contributions to tax-deferred accounts with high balances (capped).
- Reduce federal estate threshold to $3.5 million for individual/$7.0 million for married couples with no future inflation adjustments; increase top rate to 45%.
Investment Opportunity Under Clinton: Long-term investments, such as private equity or individual operating businesses, are more tax-advantaged if held for six years or longer. They are therefore encouraged under the Clinton plan. Public equity risk premiums would likely go up due to the longer hold period required to receive favorable tax treatment. For this to happen, there may need to be a material decline in the equity market to incorporate the higher risk premium. The timing of this development would likely be prior to implementation and include large wholesale selling – similar to what occurred in December 2012 when investors reset their tax basis ahead of higher tax rates effective January 1, 2013.
Subject to equity market expected returns, the best vehicle to hold stocks may be in tax-deferred accounts rather than taxable accounts. Intuitively, the larger the return in equities (albeit holding period dependent under Clinton), the greater the extent capital appreciation will be taxed at current income levels. For larger capital appreciation levels, it would be better to have equity in a tax-deferred account over a bond, especially given current interest rate levels.
Within fixed income, municipal bonds will become more attractive due to increasing tax rates for higher earners. For the 95% of taxpayers that are expected to have no change in their income tax rate, the current allocation decisions may continue to be relevant.
The reduction in the Federal Estate Tax threshold to $3.5 million/$7.0 million will create a planning need for a larger number of families that are below but near the current $5.0/$10.0 million threshold.
Trump on Taxes:
According to a CATO Institute report, Trump would add 31 million people to the non-tax paying category or “tax eaters.” Trump’s plan, according to the Tax Policy Center, provides tax relief along the income distribution line and reduces the highest bracket materially from 39.6% to 25% (now 33% as of August). Corporate taxes would be reduced to 15%, including those for pass-through entities. Whereas Clinton wants carried interest taxed as current income, Trump is proposing it gets taxed as business income at 15%.
- Trump’s website states that those making $25K per year or $50K per year combined if married, will not pay tax.
- Eliminate the marriage penalty and the Alternative Minimum Tax and reduce tax brackets from seven to four: 0%, 10%, 20% and 25% (Tax Policy Center claims 3, but likely not including 0% bracket). During August 2016, Trump announced revising his proposed rates to 12%, 25% and 33%.
- Lower business income tax to 15% regardless of size. This is expected to eliminate inversions. Businesses will be taxed on foreign earnings in the year earned rather than when those profits are repatriated. Partnership pass-through income to be taxed as business income at 15%.
- Repeal 3.8% ACA tax.
- No death penalty tax.
Investment Opportunity Under Trump:
Equities may perform very well as corporate tax rates decline. Higher corporate dividend payouts may result depending on how receptive companies are to repatriating foreign profits and capital. Private equity and other pass-through investment vehicles would be expected to perform well due to the lower 15% business income tax rate. Risk premiums may decline under the Trump plan as capital is less burdened by tax decisions, which could give a boost to equity prices. Non-U.S. investments could be challenged, as Trump is likely to go after trade agreements in which the U.S. is deemed to be “losing”; he has specifically targeted China.
REITs and master limited partnership may do well under Trump if distributions are taxed as business income. Within fixed income, municipal bond yields become less meaningful as the tax equivalent yield is lower, all else equal, compared to taxable bonds. With lower income taxes, taxable bonds may perform well as investors keep a greater share of income.
Taxes will clearly be a major factor influencing investment allocation decisions both in terms of asset location and asset class. Depending on an investor’s marginal tax bracket, municipal bonds may be more attractive under a Clinton administration as opposed to a Trump administration. Under both administrations, long-term equity investments, such as private equity, appear to be poised for better after-tax returns. Investments through pass-through partnerships will benefit from better tax treatment under a Trump administration. Don’t change your allocations yet! What is said on the campaign trail and what is ultimately implemented can be very different. Stay tuned for more discussions on developing candidate proposals.
 Tax Policy Center “An Analysis of Hilary Clinton’s Tax Plan,” March 3, 2016
 Tax Policy Center “An Analysis of Donald Trump’s Tax Plan,” December 22, 2015.
 Cato Institute, September 28, 2015, “Trump Tax Plan Would Increase Tax Eaters”.