A Big Change Coming? Part II

03/13/2008 12:00 am EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

The squabbling between Senators Barack Obama and Hillary Clinton is getting nastier, possibly hurting whoever is the Democratic presidential nominee in November.

But as I wrote last week, a likely big Democratic majority in Congress may mean big changes no matter who's president. How will it affect the economy and investors?

In a nutshell, solid Democratic control of both sides of Pennsylvania Avenue may well mean sweeping reversals in key economic policies that have evolved over the last three decades. If Senator John McCain wins the White House, I also expect changes, but more tempered ones. This highly individualistic conservative will sometimes battle Democrats and sometimes reach out across the aisle to compromise, as he has throughout his Senate career.

I think a strong Democratic Congressional majority will have its biggest impact in four areas: taxes, health care, trade, and deficits.

The most immediate decision facing the new president and Congress will be whether to extend the Bush tax cuts, which expire in 2010. Senator McCain favors making them permanent, while Senators Clinton and Obama want them repealed for households whose income is more than $250,000.  The two Democrats favor additional tax relief for middle- and lower-income families and keeping the estate tax (with some modifications).

A victory by either Democrat would mean that the Bush tax cuts are toast, and top marginal rates may head back up to where they were in the Clinton years (from 35% to nearly 40%). Estate tax relief would be limited, and, in a classic case of the killing the goose that laid the golden egg, capital gains taxes may head higher.

And despite his promises to uphold the Bush tax cuts (which he voted against twice in the Senate), a President McCain would be hard pressed to get them through a Congress with a strong Democratic majority. The likely result: a tough compromise that probably included some increases in marginal rates for high earners, continuation of the estate tax, and no increase in capital gains levies. That would still be a bitter pill for supply-side Republicans to swallow.

The Democrats are gung-ho to repeal the tax cuts because they need a pot of money to fund their pet project-health care reform, a big issue among Democratic primary voters.

Senator Clinton, the "health care candidate," has the most ambitious plan, requiring everybody to buy health care insurance just as we all have to pay Social Security taxes. Senator Obama's "mandates" cover only children. Both provide some relief for small businesses and low-income people, and both would create a "pool" of private plans and one public plan; neither advocates going the single-payer route.

Senator Clinton's campaign estimates her plan would ultimately cost $110 billion a year, which she claims would be fully paid for by additional cost savings and limiting tax exclusion from employer plans-and, of course, from repealing the tax cuts. Senator Obama's plan would cost about half as much, his campaign says, and would be paid for by similar measures as Senator Clinton's. If either one is elected, we can count on a big new health care plan being passed and signed in 2009.

Senator McCain, on the other hand, opposes mandates and instead proposes $5,000 tax credits for families to purchase private insurance. Under a McCain Administration, even a strong but not overwhelming Democratic majority in Congress would find it tough to overcome presidential opposition on this issue. So, any mandates would probably be dead in the water, and a President McCain might even get parts of his own program through.

A McCain Administration also would be consistently pro-free trade, but might have a rough time with growing protectionist sentiments in a Democratic Congress. Senators Clinton and Obama fell all over each other denouncing the North American Free Trade Agreement before the Ohio primary. In an earlier column, I warned investors to watch for the emergence of populist or protectionist sentiment in the campaign. Don't expect it to cool down much as the two leading Democrats head for a showdown in Pennsylvania next month. 

This hot rhetoric-combined with legitimate anxiety over the loss of millions of US manufacturing jobs over the last few years-will make it very difficult for any future US president to negotiate trade deals that have any chance of passage in a much more heavily Democratic Congress.

Finally, there's the deficit, a subject that hasn't exactly been front and center, although Senator McCain has made an issue over "earmarks" and other Congressional pork-barrel spending.

But that's just a drop in the ocean. The Bush Administration projects a budget deficit of $410 billion this year, more than double 2007's $163 billion, which was a five-year low.

Don't expect much improvement, even if the Bush tax cuts expire and a Democratic president reduces the $12 billion a month we're currently spending in Iraq and Afghanistan: the Democratic candidates' ambitious health care, education, and energy plans will cost a bundle, and they'll find little opposition in a strongly Democratic Congress.

The candidates have been at pains to explain how they'd pay for these goodies. But isn't that what everybody said when the Medicare prescription-drug benefit passed? And that program will probably cost at least twice as much as was predicted.

And what about the elephant in the room: Social Security and Medicare spending? As Baby Boomers retire and health-care costs balloon, these existing entitlements may add trillions of dollars to our national debt. "If tax revenues as a share of GDP remain at current levels, additional spending for Medicare, Medicaid and Social Security will eventually cause future budget deficits to become unsustainable," the Congressional Budget Office wrote recently.

Are any of the three remaining candidates prepared to take on that critical issue? With a strongly Democratic Congress, I don't think so.

Like the election, these concerns seem far in the future now. But smart investors who are buying gold and selling the dollar are clearly looking beyond the next Federal Open Market Committee meeting.

Given how things are likely to go down in Washington next year, it may be only a matter of time before the rest of us catch up.

Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his own and do not necessarily reflect the views of InterShow.

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