A Democrat clean sweep and corporate America

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Lex Hall: It's been a tumultuous time in US politics, to say the least. The Trump era is seemingly over. The Democrats now control both the House and the Senate. What will this mean for corporate America? With me to discuss that is Aron Szapiro. He is Morningstar's head of Policy Research.

Hi, Aron.

Aron Szapiro: Hi. Thanks for having me.

Hall: My pleasure. Now, in a recent piece you mentioned that one of the big changes under the Democrats might be an increase in the corporate tax rate. What sort of effect do you think that will have on corporate America?

Szapiro: Yeah. Well, I mean, obviously, as taxes go up, free cash flow goes down and so, the fair values—our fair value estimates will probably fall a little bit as they rose. But I do think it's important to keep these things in overall context. Corporate tax rate was at least officially—there are a lot of deductions and loopholes and what have you—at 35 per cent from 2010 through 2000—well, further back, but certainly from 2010 to 2018. That wasn't exactly a period that was not economically dynamic in the US And I don't think we're going all the way back to 35 per cent. I think it will be a 6 or 7 percentage point increase off the current 21 per cent, right? But yeah, I mean, taxes go up, cash flow goes down. So, that's a pretty direct relationship.

Hall: Okay. And what sort of measures do you think the Biden administration will undertake? Where will they channel this money do you think?

Szapiro: Yeah. So, what we think is most likely is that Biden will have to deliver something on enhancing the Affordable Care Act. So, there are a couple of ways to do that, and they're all pretty expensive because healthcare is pretty expensive. So, one way would be to expand our Medicaid program. So, it's a low-income program to deliver healthcare. Another would be to bolster the subsidies that people get when they go and buy healthcare on the exchange market that we have. So, we've estimated that those kinds of interventions will cost somewhere between $85 billion and $100-plus billion a year. Now, every percentage point increase in the corporate business tax rate nets about $100 billion over 10 years, about $10 billion a year. So, you can kind of see why we think somewhere in that 7 percentage point range, plus maybe a few other kinds of revenue raisers would cover that sort of healthcare expansion. That's what we think is most likely.

Hall: Okay. Every day it seems that the market jumps or falls on the talk of COVID stimulus checks. But you in a recent piece sort of arguing that that has less effect. What were your reasons for that?

Szapiro: Yeah, when we look into this—I mean, we do think that the stimulus, that additional stimulus will have an immediate effect, but we tend to think it's just likely to pull the recovery forward a little bit, and that's because we're very bullish on a true V-shaped recovery once you get vaccines out and into people's arms. It's obviously something that the US has struggled with, but we do have two vaccines that are very effective. There may be more coming soon. And we think that's going to be the big driver of further recovery, and it's a lot more important than stimulus if you're taking a 2, 3, 4-year view of things.

Hall: One industry we've talked a lot about at Morningstar is cannabis and that the cannabis stocks have shot up on talk of legalization under a Biden government. Are there any other industries and sectors that you think will benefit from the Democrats being in power?

Szapiro: Well, I mean, I do want to say on cannabis. I mean, a lot of that is because the Trump administration was pursuing legal action where they could under existing law, although not as—it could have gone further and some of the states, they could have said we're shutting you down, you can't legalise things, but I'm not sure it's that big of an inflection point from a legislative perspective.

In terms of other industries, I mean, I think the conventional wisdom is generally correct that you're going to see more enforcement, somewhat more regulation under a Democratic administration than you've seen certainly under this previous administration. But when we – we've done a deep dive that will come out a little later this week. In general, we really look at the kind of rulemaking we think it's going to come out, and the kinds of new regulations, we don't think it will be particularly harmful to most industries. We don't think that most of these regulations will have a material effect on companies and we generally don't think they're going to change our fair value estimates.

Hall: Well, let's turn to climate change in that case, because you think the probability of major new investments in clean energy is quite low. Why is that?

Szapiro: Yeah. I mean, again, with only 50—with the narrowest majority you can possibly have, you have to sort of start looking at the median senator in the entire Senate, and the more rightward leaning senators in the Democratic caucus. And those senators, particularly Joe Manchin from West Virginia, Jon Tester from Montana to maybe a little bit of a lesser degree, they're pretty sceptical. It's not that they are totally opposed to doing things that would mitigate climate change, but they represent states that are heavily dependent on traditional fossil fuels and fossil fuel coal traction and the like? And so, to sort of project that's something really big will happen there, given all the other challenges that Congress has keyed up for themselves. Healthcare is a Democratic priority. They've pretty much locked into doing additional stimulus for state and local governments, but also just sending more checks to people.

It's like really only so much Congress can do in the sort of narrow window, and they've just been elected and when they start running for reelection again. And just given that dynamic in the Senate, I'm pretty sceptical they'll be able to do a really big transformative thing. Maybe some things around the edges. It's also worth noting that a lot of the kind of things you might want to do on climate change can't be done with 51 votes. They would require 60 votes. I'm not going to get into the arcane reasons around that, but that's definitely not going to happen.

Hall: And finally, at the top of this interview, I said the Trump era is seemingly over. Can the Republicans come back within four years as they've been talking about?

Szapiro: Within two years. I mean, there are midterm elections every two years where the whole House of Representatives are up for election in the US Traditionally, presidents lose seats and the Democrats have a pretty narrow majority in the House as well. There's also a bunch of redistricting that's going to happen. We've been kind of trying to game this out.

So, Democrats are pretty vulnerable. The last President with one asterisk. You have to go back to 1982 for a non-wartime president to have expanded his party's majority in the House of Representatives in the first midterm. And even Reagan didn't win the house back, he just picked up a few seats.

Now, in 2002, Bush was able to expand the majority. But we were—9/11 had just happened. It was an unusual circumstance. So, it's very, very very, tough for a first term president to expand that majority. Obama lost his majority in the mid-term. Trump lost his majority in the mid-term. That's what usually happens. That would certainly this—just you probably wouldn't go broke betting against that—against the Democrats retaining the majority.

This report appeared on www.morningstar.com.au 2022 Morningstar Australasia Pty Limited

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