Tax Hikes and Wall Street Regulation: The Democrats’ Vision of American Economic Policy

Now that Iowa caucuses are over and Americans have fewer candidates to choose from, it is highly important to understand what these candidates can offer for the economy and how their solutions for the US can affect the rest of the world. After getting less than 5%, some participants decided to cease the campaign immediately. There are fewer politicians to choose from, but both parties still struggle to choose their sole leader at the early stage. Most probably, intrigue is left for the Super Tuesday, when 24 states will be voting in Republican and Democratic primaries. While GOP still has a number of candidates running, Democrats are left with two, after Martin O’Malley dropped out of the race, winning only 0.6% of votes in Iowa. Clinton-Sanders tie in Iowa promises an intense campaigning and tough debates through the next few months.

At the first sight, Hillary Clinton and Bernie Sanders’ campaigns seem alike. According to The New York Times, they voted identically in Senate 93% of the time. Now, though, they try to differentiate themselves from each other in many ways. Both have presented liberal agenda. The scope of the planned projects, however, is much different. Self-described “democratic socialist” Bernie Sanders has come much further with his proposals.

The ones of most interest to economists are taxes and the Wall Street regulation. Senator Sanders and former Secretary of State Clinton’s views of these particular issues are spread apart far enough. They both agree on the direction of movement – higher taxes, more government spending, and tougher regulation. The exact numbers, yet, do not match.

Both of the Democratic candidates pledged substantial expenses on social programs. Bernie Sanders’ most expensive promise is Rebuild America Act ($1 trillion in 10 years), which is expected to rebuild infrastructure and create 13 million jobs. Hillary Clinton’s plan is not so generous; she only plans to spend $275 billion over a 5-year period. Nevertheless, to pay for either of those – a significant tax increase is certainly in order. The candidates agree that wealthy Americans do not pay their fair share of taxes and taxing few wealthy people and large corporations will not hurt them, but the poorest Americans will feel the difference.

Senator Sanders proposed to reform the corporate tax code, closing many loopholes, especially those concerning offshore operations. He says he will end offshore tax schemes of US corporations by giving a right to tax the foreign profits of American companies. He also would regard companies as American if their management and operations are located in the US, no matter where their post office box is. To make a plan complete, Senator will end corporate inversions. This occurs when an American business merges or acquires a small foreign one and register in another company for tax purposes. These measures are estimated to add $100 billion to the budget.

Most revenue for new social programs is going to come from Wall Street. To eliminate high-frequency trading, Senator Sanders will impose a tax on each financial operation: 0.1% for bonds, 0.5% for stocks, and 0.005% for derivatives. He states that in such case only high-frequency trading will be hurt. Moreover, he insists that only hedge funds and investment houses, but not the individuals, will be affected. Vermont Senator plans to raise $300 billion each year. Besides proposals stated above, the senator also wants to remove payroll tax cap of $250,000, introduce a progressive tax on inheritances over $3.5 million, stop subsidizing fossil fuel companies, etc.

Hillary Clinton’s tax plan is similar in some way. Except for the fact that “it isn’t bold enough”, according to Michael Briggs, Sanders’ campaign spokesman. Many of her suggestions are the repetition of those of Sanders but on a smaller scale. Former Secretary of State is in favor of continuing “Buffet rule”, and apply a minimum effective tax rate of 30% on income higher than $1 million. Besides, Mrs. Clinton wants to add a 4 percent “surcharge” on annual income of more than $5 million.

In addition, both candidates agree on increasing the tax on capital gains, the profit from reselling an asset at a higher price. The actual rate of 23.8% will jump to 60% under Sanders’ plan and to 47.4% under Mrs. Clinton’s proposal. Both Democratic candidates also pledged to close so-called “carried interest loophole”. It allows wealthy hedge fund managers recognize their bonuses as capital gains from their fund’s investment, not as ordinary income, and pay 20 percent tax rate instead of 39 percent.

Eight years after the great recessions, reforming Wall Street is still one of the key issues. Like with taxes, both politicians agree that major changes should take place. Hillary Clinton concentrates on better risk management: size-based risk fee on large financial organizations, giving authority to government institutions to influence risky companies, tackle shadow banking, improve Volcker’s rule (prohibition of trading with their own accounts, as opposed to depositors’ money), which is now being violated. These propositions seem moderate comparing to Mr. Sanders’ ones. He insists on breaking up “too-big-to-fail” banks and reinforcing Glass-Steagall act of 1933, which divided commercial and investment banks. Moreover, both support personal responsibility of bankers for the critical mistakes and high-frequency trading tax.

It is clear that these policies will greatly affect financial industry and corporations. Now, in times of globalization it is much easier for companies to move operations overseas, especially services such as investing or banking services. It is a big question, however, if it will be worth it – European, Japanese or Chinese regulations and tax systems are fierce enough to make a change of location useless, so the US may remain one of the best places for doing business. At the same time, reforms, if done properly, may reduce instability of the financial system and decrease inequality in America.

Summing up, Hillary Clinton and Bernie Sanders have an almost typical progressive agenda. Yet Bernie Sanders, an outsider, with strong “democratic socialist” plan managed to add interest to the Elections, he even made his opponent be more aggressive on Wall Street to catch more votes from the Democrats fed up with inequality. High taxes, regulation and a high level of government intervention have always been a prerogative of the Democrats. It worked with Barack Obama – his approval ratings are hitting 46 percent now, what is almost as high as Reagan’s popularity and significantly exceeds George Bush’s figures. We can only hope that the next presidents will be able to cope with inequality and, at the same time, make businesses stay in America.

By Filip Drazdou
Market Analyst at the Investment Fund