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October 18, 2024 | 12:56
2024 U.S. Election: Macro and Market Impacts
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2024 U.S. Election: Macro and Market Impacts |
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Key messages
Potential macro and fiscal impactsRegardless of who wins the White House and which party controls the House and Senate, we assume that most of the expiring Tax Cuts and Jobs Act measures will be extended beyond 2025 to avoid a large economic impact. The Congressional Budget Office (CBO) estimates that the cost through FY2034 of extending the expiring measures would add $4.6 trillion to the cumulative deficit [1]. Absent an extension, the impact on after-tax personal incomes in 2026 is estimated at $290 billion. To the extent the latter are reflected in higher withholding taxes and lower consumption to start the year, there could be as much as a 4-ppt hit to annualized GDP growth in 2026 Q1 and a 1-ppt headwind for the full year. For this reason, there would likely be strong bipartisan support to extend most of the tax cuts. Even before any new proposals, the CBO projects the 10-year cumulative deficit will amount to $22.1 trillion, or $2.2 trillion per year (averaging 6.3% of GDP). This will cause the federal debt held by the public, which is close to 100% of GDP currently, to exceed the previous post-war record high of 106% by 2027 and climb to 122% in 2034. The debt could rise even faster if it puts upward pressure on interest rates. The rising debt will constrain fiscal flexibility and risks a fiscal crisis if bond investors demand a higher premium to lend to the government. The Penn Wharton Budget Model (PWBM) suggests that the U.S. debt could become unsustainable if it rises to 175% of GDP [2]. While the country is a long way from that tipping point, the debt ratio can rise sharply during economic downturns—it jumped 30 ppts in the four years after the start of the Great Recession and 18 ppts in the similar period after the COVID-19 pandemic. Scenario 1: Democrats control both the White House and CongressThe Committee for a Responsible Federal Budget estimates that Harris’ proposals would increase publicly held debt by an additional $3.5 trillion from 2026 to 2035 relative to a status-quo baseline [3]. The federal debt would rise from around 100% of GDP currently to 133% in 2035 (Chart 1). |
The PWBM estimates that expanding the Child Tax Credit and Earned Income Tax Credit, permanently extending the tax credit that lowers health insurance premiums, and providing down-payment support for first-time homebuyers could increase the 10-year primary deficit by $1.2 trillion. But negative economic feedback effects from raising the corporate tax rate from 21% to 28% would boost the shortfall further to $2.0 trillion [4]. This analysis does not include potential higher taxes on wealthy households, which could result in a smaller primary deficit to begin with. The PWBM suggests that 95% of Americans would see lower taxes, while high-income earners would pay more taxes [5]. |
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The higher budget deficit would provide a modest economic boost, with a partial offset from higher taxes. The Tax Foundation estimates that raising the corporate tax rate to 28% would reduce long-run GDP by 0.6%, largely by curbing business investment [6]. The economic lift under a Democrat sweep would likely not be large enough to materially alter the inflation or interest rate outlooks. Scenario 2: Republicans control both the White House and CongressThe Committee for a Responsible Federal Budget estimates that Trump’s proposals (excluding the removal of the cap on state and local tax deductions (SALT) would increase publicly held debt by an additional $7.5 trillion between 2026 and 2035 from the baseline, or almost twice as much as Harris’ plans [7]. Trump’s promised extension of the 2017 tax cuts to households earning over $400,000 adds $2.35 trillion to the debt, and the reduction in corporate tax rates to 15% adds $0.2 trillion. The federal debt would rise to 142% in 2035 (Chart 1), or 9 ppts higher than under Harris’ plans. A separate study suggested that removing the cap on SALT deductions would reduce federal revenue by up to $1.2 trillion over a decade [8]. The PWBM estimates that extending the 2017 tax cuts in their entirety, eliminating taxes on Social Security benefits, and lowering the corporate tax rate to 15% from 21% would increase the 10-year primary deficit by $5.8 trillion. The net positive economic feedback effects from lower taxes would reduce this to $4.1 trillion. This latter figure is $2.1 billion higher than under Harris’ proposals [9]. The Tax Foundation says reducing the corporate tax rate to 15% would lift long-run GDP by 0.4% [10]. However, it also estimates that a 10% across-the-board tariff would raise taxes on American consumers by more than $300 billion a year and reduce U.S. GDP by 0.7%. Retaliatory action on U.S. exports would reduce GDP a further 0.4%, for a total reduction of 1.1%. A new 60% tariff on all imports from China would increase U.S. taxes by over $200 billion and lower GDP even further [11]. The Peterson Institute for International Economics estimates that higher tariffs (including a broad 20% increase) would overwhelm the lift from fully extending the 2017 tax cuts [12]. The Wall Street Journal recently cited one estimate that the average U.S. tariff would jump to 17% from 2.3% in 2023 and 1.5% in 2016 due to a 60% duty on China and 10% levy on other countries, the highest since the 1930s. BMO Economics believes the U.S. economy could see an initial material lift from corporate tax cuts and a larger budget deficit, but the adverse impact from tariffs and a potential trade war could eventually mitigate the gains. Less immigration might also undermine employment growth. Inflation, interest rates and the U.S. dollar would likely be higher than in the other three scenarios. Equity markets might rejoice initially at the prospect of lower corporate taxes, less regulation, and a firmer economy (recall, markets rallied immediately after Trump’s 2016 win). However, a possible trade war and credit-rating downgrade could lead to increased volatility in markets. Looking back at past election cycles, the S&P 500 has only slightly outperformed when a party controls all levels of government. Scenario 3: Democrats win the White House but Congress is dividedFor the most part, the status quo would prevail, implying little net impact for the economy and markets. BMO Economics would likely not need to materially adjust its economic forecast. Scenario 4: Republicans win the White House but Congress is dividedTrump would be free to pass most trade protectionist measures as the president has almost full discretion to impose tariffs on nations judged to have an unfair trade advantage over U.S. firms or that pose a national security threat. However, imposing a broad tariff on all countries could run into judicial resistance. Higher tariffs would have a negative impact on the economy, especially if they were met with retaliatory actions. While the inflationary impact would likely be partly tempered by a firmer U.S. dollar, disruptions to supply chains could lead to higher costs and prices. Depending on whether the economic or inflation impacts dominate, the Fed might need to adjust its policy stance accordingly. This might be the worst-case scenario for equities, as investors face the uncertainty and fallout from increased trade protectionism without the benefit of a fiscal boost to growth. A Trump administration could pose a threat to the continent-wide free trade agreement. A country can pull out of the USMCA with six months’ notice, though it is unclear whether congressional approval is required. The agreement also comes up for review in 2026, when members may decide whether to renew it beyond the pre-set termination date of 2036. Trump has already sent notice that he will push for changes during the review. Threats to the agreement’s existence would harm business investment, especially in the two smaller nations. Trump also would not require the approval of Congress in order to implement some deregulation measures. Moves to lower bank capital requirements could lead to additional lending and give the economy a slight lift. The Inflation Reduction Act, and the suite of tax credits that it provides for electric vehicles (EVs) and other clean energy technologies, could be heavily modified. The credits have been in the Republicans’ crosshairs since day one. Even if Trump wins but Congress stays divided, there are executive actions that he could use to narrow the interpretation of the guidelines and repeal some credits. |
Oh CanadaUnder a Republican sweep, Canada’s economy might benefit initially from stronger U.S. growth, while energy producers would rejoice if the Keystone XL pipeline was resurrected. However, the country could be one of the hardest hit (along with China and Mexico) from a possible trade tussle with its largest trading partner. Uncertainty about tariffs and the fate of the USMCA could depress capital flows to Canada and weaken domestic investment, likely extending a productivity slump. This could cause the Canadian dollar to depreciate and undermine the TSX. While tariffs might add some upward pressure to inflation, the weak economy would likely pull inflation below the 2% target, keeping the Bank of Canada in full easing mode. The federal government might need to adjust corporate tax rates to prevent investment from migrating south. This, and the need to support a weak economy with broader fiscal support, would lead to a larger budget deficit, worsening the country’s long-term economic prospects. Moreover, Trump’s pledge to curb immigration and deport illegal residents could impede the Canadian government’s goal of slowing population growth if flows increase across the U.S.-Canada border. Other considerationsUnder a split Congress, the party controlling the Senate has the power to approve or reject the President’s nominations for ambassadors and Supreme Court judges, possibly casting a long-term influence over economic and social issues. Donald Trump appointed Fed Chair Powell in 2018 but says he will not reappoint him upon expiration of his second term as chair in early 2026. If Trump wins and the GOP controls the Senate, he could handpick nominations to the Fed’s Board of Governors, which might increase uncertainty for investors. The federal debt ceiling becomes binding again on January 2, 2025, with Treasury resorting to “extraordinary measures” to keep the government financed for a short while. The debt limit will eventually need to be lifted early next year, and a divided Congress would pose the usual challenges. [1] https://www.cbo.gov/publication/60271 [^][2] https://budgetmodel.wharton.upenn.edu/issues/2023/10/6/when-does-federal-debt-reach-unsustainable-levels [^][3] https://www.crfb.org/papers/fiscal-impact-harris-and-trump-campaign-plans [^][4] https://budgetmodel.wharton.upenn.edu/issues/2024/8/26/harris-campaign-policy-proposals-2024 [^][5] https://www.cbsnews.com/news/kamala-harris-platform-policy-positions-2024/ [^][6] https://taxfoundation.org/blog/trump-harris-corporate-tax-proposals/ [^][7] https://www.crfb.org/papers/fiscal-impact-harris-and-trump-campaign-plans [^][8] https://www.wsj.com/politics/elections/trump-salt-state-local-tax-deductions-aff00b27 [^][9] https://budgetmodel.wharton.upenn.edu/issues/2024/8/26/trump-campaign-policy-proposals-2024 [^][10] https://taxfoundation.org/blog/trump-harris-corporate-tax-proposals/ [^][11] https://taxfoundation.org/blog/donald-trump-10-percent-tariff/ [^][12] https://www.piie.com/research/piie-charts/2024/trumps-bigger-tariff-proposals-would-cost-typical-american-household-over [^] |
Appendix: Key Party Proposals
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