The record voter turnout and record early voting in 2020 have been just one indication of how high emotions are running during this election. Our team continues to be asked what this election means for markets and individuals’ portfolios. Our answer is, “Possibly less than you might think.”

People have had extremely strong opinions about Trump and Biden. As a nation, most of us care deeply about the outcome. While there are important policy ramifications that will impact all of us, history has shown that the broader markets don’t care which party is elected, yet people are still concerned about the outcome.

Nick Murray, a financial advisory professional for more than 50 years, says his network of thousands of financial advisors reported more election-related anxiety among investors before the 2020 election than ever before. In his October 2020 Client’s Corner newsletter, Murray advised, “Take your political convictions completely out of your investment decision making…The mistake a lot of investors seem hell bent on making these days is thinking that the person and policies of the president are importantly correlated to the stock market. There is zero basis, in fact, for this conviction.”

What has been the difference when different parties controlled different branches of the government? YCharts analyzed stock returns going back to 1930 under three separate scenarios. When one party controls the White House and both houses of Congress, the Dow averages 10.7 percent annual returns. When there’s a split Congress, stocks average 9.1 percent returns. But when the president is in the party opposite of both the House and Senate, stocks have delivered 7 percent average annual return.

We Can’t Predict the Future

As the world learned in 2016, what looks certain to happen doesn’t always materialize.

On the night of the 2016 election, as more states began reporting and a Trump victory became increasingly likely, stock market futures sank rapidly. Everyone was sure that Hillary Clinton had clinched the election. The S&P 500 fell more than 5 percent in premarket trading, and trading was halted.

But by the time the market closed the day after the election, the index was up more than 1 percent. Before November 8^th, 2016, pundits predicted an instant recession, markets tanking and stocks sinking. However, between 2017 and 2019, the average annual price return for the index was more than 14 percent.

It’s futile to try to predict the future, and with a proper plan, you don’t have to! Looking at historical trends about stock market performance before, during and after presidential elections can help us set our expectations (with a healthy dose of salt).

What History Tells Us About How Elections Affect the Markets

One steady trend is that, historically, volatility in the stock market increases in the months leading up to an election.

Researcher Dan Clifton notes these additional market trends during elections:

• If the S&P 500’s performance in the three months leading up to Election Day is positive from the three-month mark through the close of Election Day, the incumbent party historically wins. Since 1928, this indicator has predicted 87 percent of election outcomes and every election since 1984.
• When looking at the four-year presidential cycle since 1928, the year before the election has the strongest average returns, at 12.8 percent.
• Since 1936, open presidential election years have historically returned just 2.5 percent on average, while presidential re-election years have returned 10.3 percent. 
• In election years when the incumbent party won, the S&P 500 averaged 10 percent returns versus 2.8 percent in years when the incumbent party lost.

These are interesting trends to watch, but again, they do not predict the future. Flukes are always possible, as we saw in 2016!

Do U.S. Stock Returns Fare Better with Democratic or Republican Presidents?

Bespoke Research shows that since 1900, the Dow Jones Industrial Average has gained 4.8 percent annually, regardless of which party is in the White House. However, stocks do better in the lead-up to elections when America is signaling a Republican presidential win.

Peter Lazaroff, author of Making Money Simple, says U.S. stock returns have been much better when a Democrat was the president. His conclusion is based on his review of total returns for the S&P 500 during presidencies since 1929. However, he says it would be a mistake to conclude that stock returns were higher because a Democrat held the presidency.

Lazaroff says there is no conclusive evidence suggesting the U.S. president’s party has any statistically significant impact on U.S. equity market returns. Stock returns are influenced by myriad factors, including valuations, corporate profits, business cycles and monetary policy. Plus, the S&P 500 generates more than half of revenues outside the United States. The increasingly global economy reduces the overall impact of the actions of a single government.

Don’t Mix Your Portfolio with Politics

As always, we recommend looking to the long term when assessing your portfolio’s performance. Making knee-jerk decisions about your finances while feeling strong emotions of any kind never ends well.

According to a new report from SunTrust Advisory Services, people who have sold U.S. stocks to protest any winner of past presidential races, whether Democrat or Republican, has meant losing out on skyrocketing returns during the new president’s first year in office. Keith Lerner, chief market strategist for SunTrust, wrote in a report in October 2020 that for most years from 1933 to 2019, markets “have done well under a range of political scenarios,” regardless of which party occupied the White House. He adds that over the past 15 years, despite U.S. politics becoming increasingly acrimonious, the S&P 500 still outshined, with a 20 percent-plus return, during the first year of any president following an election. on Monday. “We strongly caution against mixing portfolios and politics.”

It Doesn’t Really Matter Who Wins

Resist the temptation to exit the market during tumultuous times. Nick Murray says, “When you radically alter your long-term portfolio because of current events—even when you tell yourself it’s ‘just this once, and just briefly’—you’re not investing anymore. You’re gambling. Too many people find to their regret that once they’ve crossed that line, they’re never able to get back.”

It doesn’t really matter who wins our elections. Those who are voted into office won’t be in office forever anyway. In November 2022, the entire House of Representatives and a third of the Senate will have to face the voters again. If any party moves too far with policies the general public dislikes, they will most likely be voted out.

So go ahead and celebrate or complain about the outcome of the 2020 election. Just don’t make any changes to your investment strategy based on how you feel about it. The key is to work with a trusted advisor to develop a plan based on your needs today and in the future. The plan must be dynamic and updated as circumstances change in your life, tax rules change or your portfolio becomes overweighted in any single asset or sector.

Regardless of who is president, and regardless of any turmoil in the markets, we strongly advise that you stick to your long-term plan. What happens week to week, month to month or even year to year is not important. Your long-term ability to maintain and enhance your standard of living is what matters most. Trying to time the markets simply doesn’t work ,whether there is concern about an election or any other event. We expect new challenges for investors as inflation increases, volatility continues and tax laws evolve. These challenges also present an opportunity for those who are prepared both financially and psychologically. We have been told that the 2020 election has been the most important in our lifetime—but so will the elections in2022, 2024 and every two years after.

Our team is here for you and your family. We have developed and refined our Personal Vision Planning Process® over the past 30 years for times like today. Please reach out to me personally, at (440) 974-0808 or randy.carver@raymondjames.com, or to any of our team, with questions or if we can otherwise be of service. Your vision is our priority.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Randy Carver and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Diversification and asset allocation do not ensure a profit or protect against a loss.

Much of the following are topics I have written about before. Yet we continue to come back to the same debate about income tax rates and what the top 1 to 10 percent of America’s income earners should pay.

There is a perennial debate about how much income tax should be paid by whom. Moreover, there is much discussion of making sure the top 1 to 10 percent pay “their fair share.” Ironically, and somewhat counter-intuitively increasing the marginal tax rates will lower the effective amount the government collects. This phenomenon is illustrated by the Laffer Curve.

The Laffer Curve is a theory that supply-side economist Arthur Laffer (who is from Youngstown) developed to show the relationship between tax rates and the amount of tax revenue collected by governments. The curve is used to illustrate Laffer’s argument that sometimes, cutting tax rates can increase total tax revenue. The Laffer Curve was used as a basis for tax cuts in the 1980s with apparent success, but some criticized the theory on the basis of its simplistic assumptions and on the economic grounds that increasing government revenue might not always be optimal.

The Effective Tax Rate vs. the Marginal Tax Rate

Misunderstandings about two different types of tax rates often create confusion in discussions about taxes. A taxpayer’s average tax rate (or effective tax rate) is the share of income that he or she pays in taxes. In contrast, a taxpayer’s marginal tax rate is the tax rate imposed on his or her last dollar of income.

Taxpayers’ effective tax rates are usually much lower than their marginal rates. People who confuse the two can end up thinking that taxes are much higher than they actually are. There is a big difference between marginal rate and the effective rate—the amount that people pay. In fact, it has been the case that by cutting income tax rates for the top 1 percent, tax revenues go up, and these folks pay more tax.

According to the Tax Foundation, the top federal income tax rate was 91 percent in 1950 and 1951 and also between 1954 and 1959. However, the top 1 percent paid an effective tax of only 16.9 percent. In 1952 and 1953, the top federal income tax rate was 92 percent. In 2019, the top marginal rate was 37 percent, yet the effective tax rate was 26.8 percent.

Politics Drive Tax Rates

Intuitively, it makes sense that if you raise tax rates, tax revenue will go up and that if you raise tax rates on the wealthiest Americans, they will pay a larger share of the income tax. The problem is that it doesn’t work that way. In fact, policies meant to help lower-and middle-income Americans often end up hurting them. This is not an economic debate; the facts stand for themselves. This is simply and, unfortunately, politics. Never before have we seen such extremes proposed as we are now.

According to the Tax Foundation, in 2016, the top 50 percent of taxpayers paid 97 percent of all individual income taxes. The top 1 percent of taxpayers paid more income tax (37.3 percent) than the bottom 90 percent combined (30.5 percent).

Yet the debate continues about raising tax rates in the face of mounting government deficits. History objectively shows us the impact of lowering tax rates. Thus, any debate about their efficacy is purely political.     

Some of today’s issues—such as health care reform, Social Security and immigration—are often difficult to quantify objectively because we have not had experience with proposed changes. On the other hand, we do have objective experience with income tax cuts and their impact.

Tax cuts have historically shifted the tax burden from middle-income people to the wealthiest Americans, while creating jobs and increasing government revenue. Critics, often with the best of intentions, have said that extending tax cuts and further reducing income taxes will benefit the rich over the poor and will lead to more deficit spending. This simply is not the case.

The only reason any informed person would propose raising income tax rates is to gain votes or to intentionally hurt lower- and middle-income Americans.

Bernie Sanders proposed a 97 percent tax on the wealthiest Americans in his Corporate Accountability Plan. Elizabeth Warren has proposed a 70 percent marginal tax rate. The Biden/Harris tax plan would increase the effective tax on those making more than $400,000. But the reality is that today, the wealthiest Americans are paying the bulk of all income tax already.

Critics of Tax Cuts Ignore History

The public is told we cannot afford tax cuts due to government spending on entitlements, defense and all the other important things the government does. While cutting taxes in the face of mounting deficits may seem counterintuitive, critics are ignoring history. Past income tax rate cuts have increased government revenues, boosted our economy, created jobs and shifted the tax burden away from low-income families to the middle- and upper-income folks.

There is no doubt that we will have to deal with excessive government spending to balance the federal budget. Independent of that, extending and expanding the recent tax cuts, while closing loopholes, is a proven way to increase government revenue and benefit all Americans. This strategy shifts the tax burden to those who can most afford it.

According to US Treasury statistics, The Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L. 97-248), also known as TEFRA, increased revenues by $130 billion in its first four years — after tax rates were cut dramatically. The top rate was slashed from 70 percent to 50 percent.

TEFRA achieved its increased tax revenues by accelerating estimated tax payment schedules; imposing strict new compliance provisions, including new withholdings and heavier penalties; levying additional excise taxes; scaling back existing benefits; and closing several significant loopholes. TEFRA reduced the budget gap by generating revenue through closure of tax loopholes and introduction of tougher enforcement of tax rules, as opposed to changing marginal income tax rates.

TEFRA was created in response to the recession at the time. The legislation faced fierce opposition from those who felt that taxes should be increased, not decreased, to offset government shortfalls. Sounds like a familiar debate, doesn’t it?

The Economic Recovery Act of 1981, also known as the Reagan tax cuts, was the biggest reduction in U.S. taxes of the past 70 years, possibly even the biggest ever. These cuts were then followed by a series of tax increases that, if you add them all together, were almost as big as or even bigger than the 1981 cuts, depending on the measure you use.

A Bloomberg analyst believes the 1981 tax law was a positive, if perhaps overdone, change in direction. He says, “Cutting the top tax rate to 50 percent from 70 percent may well have increased the amount of money coming into the Treasury, as incentives to avoid taxes were reduced and incentives to make lots of money increased.” He adds, “The positive economic and behavioral effects of the 1981 cuts recouped about a third of the revenue losses. So it also took spending cuts and tax increases to move the federal budget into surplus territory.”

Revenue Increases Typically Come from the Wealthiest Americans

The highest income people generally pay more of their incomes in taxes than the rest of us. The top fifth of households earn 54 percent of all income and pay 69 percent of federal taxes; the top 1 percent earn 16 percent of the income and pay 25 percent of all federal taxes, according to the Congressional Budget Office (CBO).

Across-the-board tax cuts had been implemented in the 1920s as the Mellon tax cuts, and in the 1960s as the Kennedy tax cuts. In both cases, the reduction of high marginal tax rates actually increased tax payments by “the rich.” It also increased their share of total individual income taxes paid. According to the IRS, in 1981, the top 1 percent of income earners paid 17.6 percent of all personal income taxes. But by 1988, their share had jumped to 27.5 percent—after the top tax rate had been cut from 69.13 percent in 1981 to 28 percent in 1988.

Reagan’s detractors point to his lack of sensitivity for social issues and the legacy of his deficit spending—yet his legacy is a positive one. In the seven years following the Reagan tax cuts, almost 20 million well-paying jobs were created. Moreover, the tax burden was shifted from low- and middle-income families. 

According to the Joint Economic Committee for the US Congress report (1996), the share of the income tax burden borne by the top 10 percent of taxpayers increased from 48 percent in 1981 to 57.2 percent in 1988. Meanwhile, the share of income taxes paid by the bottom 50 percent of taxpayers dropped from 7.5 percent in 1981 to 5.7 percent in 1988.

The middle class also benefited—“middle class” being defined as those between the 50th percentile and the 95th percentile for income. The income tax burden of the middle class declined from 57.5 percent in 1981 to 48.7 percent in 1988. This 8.8 percentage point decline in middle-class tax burden is entirely accounted for by the increase borne by the top 1 percent.

If all the intellectual energy that is being used to debate historically established facts is channeled into other subjective issues, and not promoting partisan rhetoric, all Americans will benefit.  Our team focuses on net returns for clients–what they make after income tax and expense. We take a very proactive approach for tax smart investing to minimize the income tax our clients are subject to.   

The information contained in this post does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Randy Carver and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.