The Midterms: Gridlock, Inflation and Wealth

July 25, 2022

Upcoming elections are taking place in a volatile environment, with the potential for a change in political control; they could also introduce a beneficial status quo for estate planning.

With the political season heating up, we decided to bring together two thought leaders to discuss the highly anticipated U.S. midterm elections, as well as estate planning in light of that event and the broader market and economic environment. Frank Kelly, founder and managing partner at Fulcrum Macro Advisors, sees a potential surge in Republican power that could lead to gridlock on tax and social spending, but also potentially yield some compromise on defense and security issues amid international uncertainty. Our own Sam Petrucci, head of Advice, Planning and Fiduciary Services, believes that immobility in tax policy will likely keep the focus of estate planning on inflation and capitalizing on market fluctuations. Below, we provide some highlights of their discussion.

Sam: Frank, why don’t we start with the big picture on the midterms and what your expectations are.

Frank: At this stage, I believe the Republicans are on track to win. It’s the classic scenario of the opposing party taking seats away from the incumbent President’s party. In the U.S. House of Representatives, the GOP started this process with likely gains of 10 to 15 seats, simply by virtue of decennial redistricting. Add to that the incumbent effect that I’ve noted, as well as the many problems we face, including inflation, crime and the southern border, and you’ve got prospects for a real blowout.

According to a recent poll, about 68% of Americans disapprove of Biden’s handling of the economy; and his approval rating overall is the lowest of any President at this point in his term since Harry Truman.1 If that’s where we are now, what about at the end of the summer, when people typically have hardened their political viewpoints? The bottom line, in my view, is a potential swing of up to 50 House seats from Democrats to Republicans, given the latter a majority of about 45 versus their current five-seat deficit.

Sam: Could controversy around Roe v. Wade have any impact on this? Could it favor the Democrats?

Frank: Yes, you would think, and the same might apply to the gun debate—these are deeply emotional issues that may drive specific groups of voters. But for many people, they are not motivating, and the economy could simply eclipse them.

Sam: How about the Senate? Things are much tighter there.

Frank: The Senate is evenly divided at the moment, with the Vice President carrying the deciding vote for Democrats. Here, I believe Republicans could gain two to four seats. This may depend on Pennsylvania, where Dr. Mehmet Oz squeaked by in the primary and avoided infighting when fellow-Republican David McCormick conceded during recounts. His Democratic opponent, John Fetterman, faced minimal primary opposition and has an interesting working-class persona combined with Sanders-type views. However, after he disclosed that he’d had a stroke a few days before the primary, it became clear that his health was worse than understood—which I think could hurt him politically. I’d also look at Georgia, where Herschel Walker, casting himself as more Trumpian than Trump, faces incumbent liberal Raphael Warnock, who won the election in 2020. Walker is a sports hero but also a political novice, making that contest a bit uncertain. I would also look at Nevada, where former State Attorney General Adam Laxalt—the son of former Senator Pete Domenici (R-NM) and grandson of former Nevada Senator Paul Laxalt (R-NV)—is running hard against incumbent Democrat Senator Catherine Cortez Masto.

Running Uphill: Midterm Election Gains/Losses of President’s Party


Source: Brookings Institute, Ballotpedia.

Taxes on Hold, Planning Around Inflation

Sam: Let’s assume the Republicans take both the House and the Senate. Do you think we will see any legislation over the next two to three years, or just continued gridlock?

Frank: I think that, unless the Democrats can pull a rabbit out of the hat before the election, we are not likely to see much significant legislation, with exceptions that I’ll explain in a minute. But tax hikes would likely be off the table until at least 2025, which should be a relief to many clients.

Sam: I would agree. In practical terms, that would probably mean a continuation of our planning emphasis so far this year. Overall, we’ve largely been focused on inflation’s effect on estate planning, and I think that theme continues as prices remain a concern and interest rates continue to rise.

With certain strategies, the goal is to surpass an IRS-set interest rate, above which potential returns are transferred to beneficiaries free of estate or gift tax. As those hurdle rates increase with Treasury yields, the value of using such strategies now rather than later increases. At the same time, asset prices have come down; so, if you believe that over the next two, three or four years they could come back, this presents an attractive opportunity to transfer assets at depressed levels. As a result, we’ve found a lot of interest among clients in vehicles like grantor retained annuity trusts and sales to intentionally defective grantor trusts.

In addition, we continue to emphasize the currently generous exemption from estate and gift tax, which is set to sunset at the end of 2025 (reverting back to prior levels indexed for inflation). In my view, if someone has a significant estate, why not utilize that exemption? It’s something that may be worth carefully considering.

Beyond Gridlock

Sam: Looking again at Washington, DC, in the event of a Republican sweep, are there some areas where we could see policy action?

Frank: I think you study the model of then-Vice President Biden during the Obama administration, when he worked with Republicans on taxes and other issues. In my view, he would be more likely to compromise. This may be facilitated by a potential “hockey line change” in his staff, with moderates replacing progressives in key positions.

What could that mean for policy? As I’ve mentioned, tax and social programs would probably be a nonstarter in the new Congress. After that, you have to think about where the two parties have some common ground. That could mean energy—with potential support for alternative energy and, to some degree, traditional producers. Even more, foreign policy and trade could be dominant issues over the next two years, often on an overlapping basis.

Given the challenges of Ukraine, many democracies are coming to the realization that they should work together, both on military and economic matters, to foster security. As George W. Bush put it, Biden could harness a “coalition of the willing”: In Europe, this could mean further engagement with NATO countries and other allies; and in Asia, it could mean joining forces with Japan, South Korea, India, the Philippines and others. Technology will be a key element, whether semiconductors or pharmaceuticals, given the global nature of their production and supply chains.

In history class, you may have seen those old newsreels from World War II: “The Ford Motor plant moved from making sedans and now makes Sherman tanks!” This is the kind of planning that, believe it or not, still goes on in the U.S. government, and it’s why we have something called CFIUS (the Committee on Foreign Investment in the United States), which blocks foreign ownership of certain critical industries here. Today, there’s bipartisan consensus that we have to work for economic competitiveness and security. So, I could see Biden working with the GOP in this “sweet spot” of foreign policy, defense and economics.

In the meantime, the geopolitical picture is likely to remain quite difficult in the coming months, not only with the ongoing grind of the Ukraine crisis, but worries over continued high energy costs and food shortages exacerbated by reduced agricultural products from the war zone. There have already been riots in the Middle East, which receives much of its grain from Ukraine and Russia, while India and others have curbed agricultural exports to make sure they have enough domestic supply. It’s going to take a lot of willpower for Western nations to maintain their support for Ukraine given these challenges.

Sam: All of these issues are receiving considerable attention in the markets, although probably the key focus is on inflation and interest rates, and by extension the possibility that Federal Reserve policy will eventually curb growth. Although last year many in our industry were worried about major tax reform, there’s general consensus that little, or something more modest, will get done in the coming months, let alone the next two years.

Until recently, worries about those changes helped to drive activity among planners and estate attorneys, many of whom have been busier over the last 24 months than at any other time in their careers. We are seeing continued movement to capitalize on existing tax rates and rules, for example by setting up trusts to avoid future estate taxes. And we are seeing an ongoing flight for residency purposes to states like Florida, Texas, Wyoming and Nevada.

Relatedly, we are also finding some interest in what I would categorize as “tax-efficient” investing, and that's through private placement life insurance, which essentially allows you to invest in otherwise tax-inefficient asset classes on either a tax-deferred or tax-free basis, depending on how it’s set up.

Back to Basics

Frank: Obviously, much of what’s driving the activity is taxes, but I assume there are more personal factors at play as well.

Sam: Taxes are important, and much of the activity is tied to the high inflation, rates and new level of volatility in the markets, where folks want to position their planning in relation to those factors. There are also more basic things at play. The pandemic and other recent events have created a new perspective for a lot of people around what’s truly important to them. Number one for almost anyone is health. If you have a lot of money but become terminally ill, what good is it? Beyond that, clients that we assist often worry about the impact their money could have on their children. Along these lines, the terms of the trust vehicles used in estate planning may calibrate the level of support they provide for adult children, or leave payouts in the discretion of a trustee—not eliminating that concern, but providing some guardrails.

Another issue is asset protection, because a client may love her own children, but worry about those they marry. It’s a growing element of planning because, despite recent volatility, so much wealth has been created in the past decade-plus. There was a period in the 1990s and 2000s when much of the country’s wealth was self-created, but now those entrepreneurs have grown children, and the balance has been shifting toward inheritance being the source of wealth. And again, that’s why family dynamics have become so important.

Overall, I would say that people are stressed about the state of the world and the difficult market environment, but also are cognizant that many have made money in markets over the past few years. They are taking concrete steps to preserve that wealth and plan around current turbulence. Moreover, they are drawing on the lessons of the larger world to build and add meaning to their lives, those of their children and the community around them. It’s a virtuous cycle, in my view, that cuts across personal and financial dimensions, and I’m hoping that it will act as a constructive force as we seek to move beyond partisan divides to solve the major problems of the day.

Looking to 2024

Sam: We’ve talked about 2022, but what do you think about the 2024 election? Is Joe Biden likely to run again? What about Donald Trump?

Frank: If these elections go as badly as they’re looking for Democrats, the immediate question will be, at what point on the calendar do we start seeing open challenges to Biden, like Ted Kennedy’s run against Jimmy Carter back in 1980? There’s already press on this in Washington, DC, given the President’s terrible poll members and concern that he isn’t up to the job. In the end, I think that he will bow out, and if so, probably early next year, in order for other potential candidates—Kamala Harris and Pete Buttigieg, for example—to secure fundraising and build staff.

On the Republican side, many people are saying that Donald Trump is going to run, but I don’t think he ultimately will, given his ongoing legal challenges and the level of controversy he carries with him. Ron DeSantis, the governor of Florida, should be a leading candidate, but I suspect that he has peaked. Most likely, I think that the political class will wake up after the midterms and start identifying viable candidates. This could include Glenn Youngkin, who in his run for Virginia governor projected moderation without alienating Trump voters. Senator Mitt Romney, although potentially vulnerable within the Utah GOP, is also seriously considering a run for President. And there are others—on both the Republican and Democratic sides—who are likely to come out of the woodwork, potentially marking a shift to a new generation of leaders. It’s going to be remarkable to see.

1 Source: Harvard CAPS Harris, as of June 28, 2022 (economy); FiveThirtyEight as of July 5, 2022 (popularity). Available Presidential popularity polling data begins with the Truman administration.

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