Impact of the Midterm Elections
Traditions Wealth Advisors
James Lane, Financial Analyst Intern
Brien L. Smith, CFP®, CEO of TWA
November 15, 2022
Introduction / Overview
The November midterm elections have concluded (with the exception of the Georgia Senate runoff) and the Democrats are expected to retain the Senate while the Republicans have taken the House of Representatives. The vast majority of U.S. adults (82%) rated inflation as extremely important or very important for the government to address, according to a recent poll by Monmouth University. Comparatively, fewer respondents assigned such high ratings of importance to other hot-button issues such as abortion (56%), gun control (51%), and climate change (49%).
How the midterm elections could impact the economy and your finances
Democrats have held both chambers of Congress for the past two years — resulting in a government trifecta, which is when the executive branch and both legislative branch chambers are all controlled by the same political party. With the Republicans gaining the House of Representatives there is expected to be political gridlock, where there is difficulty passing legislation.
Some feel a divided government would result in few meaningful steps to improve the economy. Bipartisan action after the midterms to combat inflation is expected to be difficult with a divided government, according to an August Wells Fargo Investment Institute report. A slight majority — 53 percent — of Americans felt the midterm election would result in divided government and gridlock, an October Axios/Ipsos poll found.
One potential implication of the Republicans gaining control of the House of Representatives is that lawmakers may attempt to make the 2017 Republican tax cuts permanent in an effort to grow the economy and create jobs. Republicans may also seek to repeal the corporate tax hikes Biden signed into law in August. Republicans are also expected to push for increased U.S. oil production in an effort to achieve self-sufficiency for energy production. However, it will be difficult to pass such legislation given President Biden and the Democratic party’s position on oil and climate change.
Democrats are expected to make further attempts to pass measures from Biden’s $1.7 trillion Build Back Better Act that did not make it into law. Critics of the Build Back Better Act — and its offshoot, the Inflation Reduction Act, which passed in August — argue that many of the measures are dedicated to spending money and are therefore bad for reducing inflation.
The Build Back Better Act contained more than $1.7 trillion in economic and infrastructure proposals. It sought to lower education and healthcare costs, as well to extend the expanded child tax credit. It failed to make it through Senate, however, after facing opposition from some moderate Democratic Senators.
The Inflation Reduction Act aims to lower inflation by reducing the deficit, curbing prescription drug costs, and investing in clean energy. It seeks to combat climate change by increasing reliance on renewable energy sources like wind and solar power, as well as reducing greenhouse gas emissions and fossil fuel pollution. The act would also increase the minimum tax rate to 15% for some large corporations.
The November midterm elections will also help decide which tax priorities Democratic and Republican lawmakers pursue in the next couple of years. And those priorities could involve tax deductions and tax incentives that directly impact your finances. After the November midterm elections, Congress will need to come to an agreement on Fiscal Year 2023 spending. That creates an opportunity for a potential year-end tax package. There are several tax issues that Congress could address in such a package depending on their appetite for negotiation.
For example, with Republicans now controlling the House of Representatives they may not be quick to support so-called lame-duck spending. That reluctance could be enhanced by the fact that the Democratic-controlled congress already passed the Inflation Reduction Act, which provides about $270 billion in clean energy tax incentives that include everything from electric vehicle tax credits to tax credits for energy efficient home improvements.
Child Tax Credit
The expanded child tax credit was enacted with the American Rescue Plan Act (ARPA) and allowed eligible families in 2021 to receive advanced payments of up to either $250 or $300 a month (per qualifying child), for six months, depending on the age of each child. Democrats and various advocacy organizations have pushed to reinstate the expanded credit, which some data show effectively helped to reduce the child poverty rate. Democrats are expected to push to reinstate the child tax credit.
Inflation Reduction Act Implementation
If Democrats are also expected to try and push the Inflation Reduction Act into law. Currently, the Treasury Department and the IRS are seeking public input to propose regulations to implement the many clean energy tax incentives in the new law. However, with Republicans taking control of the House, Minority Leader Kevin McCarthy (R-California) has vowed to block the $80 billion in funds allotted in the Inflation Reduction Act for the IRS. McCarthy and other Republican lawmakers have claimed that the funding will result in an “army” of 87,000 IRS agents coming to audit middle income Americans.
On the bright side, there appears to be bipartisan support for potentially major retirement legislation. The EARN act is designed to encourage small businesses to adopt retirement plans and make it easier for part-time workers to participate in retirement plans. The bill would also expand savers credit for low and middle-income workers and allow penalty free-withdrawals during certain emergencies. Congress will have to reconcile the EARN Act with bipartisan House-passed SECURE 2.0, which would also make significant changes to retirement plans including raising the age for taking required minimum distributions (RMDs).
Trump Tax Cuts
With Republicans gaining control of the U.S. House of Representatives, they have pledged to propose legislation to make the so-called Trump tax cuts permanent. The individual tax cuts were enacted with the Tax Cuts and Jobs Act of 2017 and many of the tax breaks tied to individuals are set to expire after 2025. In a pillar in the document that concerns the economy, Republicans say they will fight inflation and lower the cost of living in part through what they describe as a “pro-growth tax economy.” It’s unclear at this time what specific tax policies the GOP would pursue if they gained control of the House or the Senate. But President Biden would still have VETO power and Congressional override would be highly unlikely.
State Tax Initiatives: Taxing The Rich
There are tax initiatives on November midterm ballots in several states. For example, Bloomberg points out that California voters will be asked to consider Proposition 30 — whether wealthy Californians should pay more tax. Colorado voters will cast votes on whether proposed income tax cuts should limit tax deductions for wealthy residents. Notably, like many other states, California and Massachusetts are returning surplus revenue to their residents in 2022 through state “stimulus” checks. California’s second round of tax stimulus checks are underway, and Massachusetts is returning nearly $3 billion to eligible taxpayers with its 2022 Massachusetts tax refund, beginning in November and continuing through Mid-December.
Overall, Congress has been divided and political gridlock is highly likely, and analysts are expecting no major legislation to get passed into law. Historically, the stock market has done better under a split government when a Democrat is in the white house. Average annual S&P 500 returns have been 14% in a split Congress under a democratic president, according to data since 1932 analyzed by RBC Capital Markets. That compares when democrats controlled the presidency and Congress.
Coping Tips for Financial Anxiety
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Social Security Increase
The good news is that your social security payments will increase by a record amount next year. The bad news: your tax bill may also rise with it!
The cost of living adjustment (COLA) should increase retirees payments by 8.7% which will help alleviate some of the cost of inflation. Unfortunately, more retirees will owe taxes on Social Security benefits. Higher income means higher taxes but don't fret there are ways designed to plan for the tax increase and to help keep more of your retirement income next year.
Here are some tips to discuss with your tax or financial advisor to prepare for these changes in 2023 and lower your income. First, minimize taxable traditional 401(k) or IRA withdrawals, as these are taxed as ordinary income, corresponding to your marginal tax bracket, but be sure to still withdraw enough to meet any required minimum distributions. Next, consider qualified withdrawals from a Roth IRA, a Roth 401(k), or a health savings account (HSA), which would not be subject to federal income tax and wouldn't have an impact on how your Social Security benefit is taxed. (Note: Roth IRA distributions of earnings must meet the 5-year aging requirement to be tax-free, and HSA withdrawals are only tax-free when used to pay for qualified health expenses.) Finally, withdrawals from a brokerage account, where long-term capital gains are taxed at a lower capital gains tax rate, generally between 0% and 20%, if you held the investments over a year. Figuring out withdrawals from retirement and brokerage accounts can be complicated, so it may help to work with an advisor.
Further, while claiming your social security as soon as possible is tempting, it is still best to wait until your full retirement age of 67. Plus each year you delay until 70, increases your benefits 8%.
2023's cost of living adjustment can help you keep up with the higher costs. Make sure you are looking at your taxes long term and not just at this year. Whether you're planning for the next year or the next decade, managing taxes throughout retirement can be complicated. Be sure to work with a tax professional to help you understand the potential tax impacts of any planning decisions. Reach out to us for guidance and a referral at Brien@traditionswealthadvisors.com or 979-694-9100.