From Wall Street to Main Street, everyone wanted a US president who would make stopping the spread of COVID-19 his administration’s top priority. An end to the pandemic would get the country back on track and spur economic growth. But if President-elect Biden’s tax plan passes, the economy may not come roaring back even if the new administration succeeds on the virus-management front.
Given that higher corporate tax rates tend to reduce investment, and corporate taxes are negatively correlated with growth, Biden's US$1.9 trillion tax increase on businesses over the next decade would lower economic growth. On the other hand, re-electing President Donald Trump would have cemented tax cuts for workers and businesses.
Amid COVID-19-related uncertainty and the large decline in demand that resulted in many business failures, the tax hikes would come at the worst possible time. First, every American would pay higher taxes, including those at the bottom of income distribution. Second, workers – especially those from low-income households who have been disproportionately affected by COVID-19 job losses – will stay unemployed longer because of more sluggish economic growth.
Part of the Democratic Party’s narrative is that raising taxes on businesses will reduce income inequality. However, Biden’s plan may backfire. While some businesses in the technology sector and their workers may continue to thrive thanks to digital adoption, most workers and businesses would be hurt by higher taxes and more federal regulation.
Tax Hikes Will Harm The Pace Of Economic Recovery
Taxes affect the economy mostly through their impact on demand. While tax cuts can boost demand, tax increases reduce demand by lowering disposable income and by reducing business hiring and investment. These demand effects can be substantial when the economy is weak, as it is currently, amid a global pandemic.
When including the effects of corporate income tax hikes, every American would see lower disposable income under a Biden tax plan when compared to current tax law. Taxes on business profits reduce job creation and could worsen income inequality, while taxes on capital will leave everyone worse off.
Unfortunately, that makes sense. When businesses expect lower receipts because of COVID-19 lockdowns and social distancing, while at the same time facing higher tax bills, fewer businesses are formed and the expected gain from creating an additional job falls. In the end, many workers will be unemployed longer and low-income families who disproportionately lost their livelihoods during the pandemic will pay the heaviest price.
President-Elect Biden Also Favours More Regulation
Unfortunately, on top of the direct taxes on businesses and families, Biden also has proposed a slew of regulations that will be detrimental to economic growth. The president-elect plans to reinstate onerous drug approval procedures, as well as several labour regulations and other rules for the banking, mining, and farming industries.
While a more regulated banking sector may reduce the severity of future financial crises, research shows that for every 1 per cent increase in capital minimums, lending rates will rise by five to 15 basis points and economic output will fall by 0.15 per cent to 0.6 per cent. Tighter banking regulations could harm growth and constrain credit without making banks safer in return. The biggest losers would be minority-owned businesses which already struggle more than most to secure adequate financing.
By raising costs for consumers, Biden-era regulations could also disproportionately harm low-income families and minorities who have suffered most from the pandemic-induced economic downturn.
Spending Will Need To Be Better Targeted
According to an analysis published by the Penn Wharton Budget Model, a non-partisan group at the University of Pennsylvania’s Wharton School, the total price tag of a Biden presidency would exceed US$5.4 trillion in new spending over the next decade, far more than his tax plan expects to bring in.
Since the cost of public debt is low – at least for now – higher levels of public spending could mitigate the negative impact of taxes on the economy. However, the size of the economic boost will also greatly depend on how a Biden administration spends its tax dollars.
When a business invests in a project, the investment is expected to increase the company's earnings and value for shareholders. Just like businesses, government—with investors known as "taxpayers"—should only fund projects with a positive net present value. That means you only spend on projects that deliver value to taxpayers by raising incomes. In order to offset the damaging effects of massive tax increases, public funds must go where they deliver the highest return.
Biden wants to increase spending on childcare, education, health care, retirement, disability benefits, housing assistance, infrastructure, research, and climate change.
While some public investments in education, childcare, research, and infrastructure can boost economic growth, other spending may have the opposite effect. For example, research shows an increase in the level of disability insurance benefits can reduce labour force participation. In addition, an increase in public health expenditures is not positively related to per capita growth. Instead, it is the share of health expenditures on preventative care and research and development that has positive growth effects.
Lastly, and likely most pressing, Biden is expected to deliver large stimulus spending to address the pandemic-induced economic crisis. As with all of the president-elect’s proposed new spending, the success of a new stimulus package will depend on the fiscal “multiplier” – the output produced for each dollar spent. And this, in turn, depends on social distancing measures and the handling of COVID-19 across the US. Unfortunately, Congressional Budget Office estimates of fiscal multipliers for the first COVID relief package show that for most of the spending provisions, the multiplier was less than 1.
Furthermore, it appears as though a large portion of the next round of stimulus may be dedicated to state and local government bailouts under a Biden presidency. Opponents of federal bailouts of state and local governments rightly worry a bailout would unfairly punish fiscally responsible states and promote future financial mismanagement by shielding incompetent state politicians from the consequences of their decisions.
Take the state of Illinois, for example. Experts consistently rank Illinois as the second most corrupt state in the US. Since 1973, four Illinois governors have gone to prison. Not surprisingly, Illinois has the worst debt burden of any US state because of decades of financial mismanagement. Most states entered the crisis with healthy reserves, with median savings equal to about 8 per cent of their budgets. Illinois, a state desperate for a federal bailout, is in that position because of poor accounting practices and past financial mismanagement, not the coronavirus.
Suppressing the virus and ensuring the most efficient distribution of an effective vaccine should be the initial focus of the Biden presidency. This is because spending aimed directly at winning the war on COVID-19 will yield the biggest economic bang for the buck. Without a win against COVID-19, Biden’s other spending aspirations may never deliver their intended results. But even after COVID-19 becomes a distant memory, Americans’ incomes will be lower in a smaller and less competitive US economy.
Dr Orphe Divounguy
Orphe Divounguy is a Senior Economist at Zillow Group Inc. Divounguy is the former Chief Economist at the Illinois Policy Institute. Divounguy is also the founder of the Quantitative Research Group and the co-host of the Everyday Economics podcast. Divounguy’s columns and articles cover fiscal policy, labor economics, and quantitative methods for programme and policy evaluation. Contact: firstname.lastname@example.org. The views presented here do not necessarily reflect the views of his employers.