The Biden administration may yet rue its tax and spend agenda.
Writing a year ago, during the uncertain early days of the pandemic, we predicted that the US government would come to the rescue of the private sector in a manner that was likely to be transformative to the devastated economy. However, welcome and necessary as this effort would be, we also believed that it would mark the start of a long lasting and radical recasting of the relationship between the public and private sector that would far outlast the crisis itself. Historical examples of this abound, particularly in times of war. Whenever the power of the state intervenes to rescue society as a whole, it both requires and legitimises a shift in the balance between the two.
The period leading up to, including and following World War II, is covered in Daniel Todman’s excellent two volume series Britain’s War, which describes in great detail the transformation of the UK society and economy during the struggle with Nazi Germany, moving from a globally integrated, laissez faire hub of a far-flung empire to a centrally planned and narrowly focused nation state. Of course, this transformation was justified with the aim of winning the war, but victory was followed by a trend of nationalisation that was to last a generation and a socialisation of medical care that lasts until today. In the US, the attempt to unite a country at the time of conscription for the Vietnam War cannot be disassociated from the massive expansion of social benefits that took place under President Johnson.
This is hardly a uniquely 20th-century phenomenon and there are plenty of examples from ancient history. For instance, the biblical story of Joseph interpreting Pharaoh’s dreams is well known, with careful husbandry during the seven years of plenty saving the nation of Egypt in the seven years of famine that were to follow. What is generally forgotten, is that by year six the population was so impoverished that they had to trade all their herds to purchase food and that in year seven land ownership passed to the state, representing a wholesale recasting of citizenship. At the time, this shift in status was willingly undertaken: “Let us find favour in the sight of my lord and we will be Pharaoh’s bondsmen”, but we do not doubt that it was a source of resentment in years to come, especially since the priesthood were exempt from the order.
“Joseph Biden’s administration has made full use of the pandemic’s disruption to formulate an explicit programme of Federal expansion”
Fortunately, nothing quite as drastic is being proposed today, even in the increasingly radicalised reaches of the US such as New York. But a national eviction moratorium now stretching into its second year (and just extended to 31 August in New York) does bring into question what exactly it means to own property, even if the state is not itself confiscating it in return for rescuing the tenants. More generally, Joseph Biden’s administration has made full use of the pandemic’s disruption to formulate an explicit programme of Federal expansion together with extensive increases in taxation of the wealthy to pay for it. In return, the promise of large fiscal stimulus and expansionary monetary policy is meant to make the pie grow larger and the distribution of the slices more equitable.
We doubt that either aim will be straightforwardly achieved. Although much of the early Federal stimulus made a critical difference to the economic impact of the pandemic, the last two programmes have been increasingly costly and inefficient baskets of populist measures that are less and less focused on the remaining problems. For instance, only 1.5% of the last $1.9t stimulus was set aside to compensate the restaurant industry from its Covid losses, with the vast majority of funds simply sent out to industries and individuals, who may or may not have suffered economic hardship during the pandemic.
Unsatisfied with such generosity, what was originally termed a ‘fix the infrastructure’ bill has now been transformed into a massive tax and spend programme whose ultimate reach remains to be seen. At present, proposals include much higher marginal income tax rates, corporate tax and capital gains, together with the abolition of a number of very popular tax breaks for real estate and private equity investors. On the spending side, there’s a significant expansion of state welfare into the sphere of the family. All we’re prepared to predict today is that it will be as inefficient as it is expensive, and that while the wealthy will pay more along the way, the incentives to avoid or even evade taxation will be significantly increased.
As far as monetary policy is concerned, the costs are likely to be centred around inflation. The sad irony of targeting minority employment for monetary policy is that it is precisely this portion of the population that is most vulnerable to the resurgence of inflationary pressures that are increasingly obvious in the data we follow. May’s CPI report saw headline CPI soar to 5% YoY, far above estimations issued by either private sector economists or the Federal Reserve. In more normal times, this would have sparked a significant debate within the central bank as to the future of monetary policy, but instead we’ve been treated to a steady stream of governors and FOMC members explaining why the inflationary impulse will prove to be transitory and easy to reverse. We believe that neither will prove to be the case and that as a result, there is also the growing risk that confidence in the Federal Reserve will start to erode and with it the ability to anchor long-term interest rates with quantitative easing.
There will, of course, be winners of this process, be they the recipient of politicians’ favours or the unintended beneficiaries of ill thought-out programmes. It’s notable that extractive industries (miners and energy) have enjoyed one of their best ever six-month periods since President Biden was elected and are of course well-positioned to take advantage of the inflationary forces being unleashed. This is despite them being extremely unpopular among the Democratic party’s base for environmental reasons. Whether this provokes a policy response at some point in the future remains to be seen, but the upsurge in prices in the late 1960s led to a series of ill-handled attempts to control prices within the economy both for the US and UK (the latter, of course, went far further along this path), and we would not be shocked if something similar was to be attempted down the road. In the meantime, both look to be obvious destinations for investor capital, together with any portion of the industrial sector that is able to pass cost increases on to its customer base.
