The battle over the federal budget in Washington is adding to political uncertainty at a time when investors are already nervous about the economy and financial markets. This week, lawmakers in Washington D.C. continued the line of budget stopgaps to keep the government funded since last September. The fact that this is a presidential election year and GOP caucuses are underway only adds to investors' concerns over the impact of politics on their portfolios. How can investors maintain perspective during this important political year?
It's no secret that political differences between and within the major parties have grown in recent years. This is why it's always important to separate political views from portfolio decisions when it comes to financial planning and investing. As citizens, voters, and taxpayers, expressing political preferences via the ballot box, campaigning, and community organizing is essential to our democracy. However, while Washington politics affects our personal lives and legislation can impact specific industries, they don't always impact the stock market as we expect.
The federal debt is a central issue for Congress and voters
The current budget battle is just the latest in Washington's long line of issues. While the situation is still evolving, at the time of this writing, Congressional leaders agreed on a continuing resolution to fund the federal budget into March. This resolution avoids a shutdown, but this agreement between the two factions in D.C. continues to kick the can down the road.
Why has it been so difficult for policymakers to agree on a new budget? Every year since 2001, the federal government has operated at a deficit, and the federal debt has grown. Today, the federal debt stands at $33 trillion, more than ten times its 2000 levels, representing 120% of the country's gross domestic product. Even when adjusting for what the government owes itself, also known as "net debt," this number has risen to 95% of GDP. As the accompanying chart shows, the debt has ballooned during periods of economic crisis when the government spends to stimulate the economy, such as during the 2008 financial crisis and the recent pandemic.
Government borrowing to fund deficits has increased
One important distinction is that the current budget situation differs from the debt ceiling debate. Since the government operates with a budget deficit, meaning it spends hundreds of billions more than it collects in revenues, the Treasury Department must borrow funds to pay government bills. The limit on this borrowing needs to be extended periodically, resulting in heated political battles over the past decade. The accompanying chart shows that the issuance of Treasury securities has grown over time and that many domestic and foreign parties, which consist of investors, corporations, and other governments, hold these securities. Unfortunately, the next debt ceiling debate will occur in less than a year at the start of 2025, soon after the presidential election.
While the consequence of not passing a budget is a government shutdown, not raising the debt limit risks a government default on Treasury securities. These are central reasons bond ratings agencies have downgraded or threatened to downgrade the U.S. debt. Standard & Poor's did so in 2011, leading to a market pullback, while Fitch downgraded the U.S. debt from AAA to AA+ last August. Moody's, the last of the three large credit ratings agencies, has not downgraded the U.S. debt but lowered the outlook to negative last November.
Tax rates are low by historical standards
Fortunately for everyday individuals, Congress has agreed on a new tax package that includes consequential items such as the child tax credit and tax breaks for businesses. While the $78 billion package is not a done deal just yet, the fact that it received bipartisan support is a positive sign.
Taxes are always top-of-mind for households because persistent budget deficits and the level of the national debt can only be improved either with reduced spending or increased revenues. The last balanced budgets occurred during the Clinton and Nixon administrations, at the turn of the century and in the early 1970s, respectively. Thus, many worry that taxes could increase in the coming years. As shown in the accompanying chart, the highest tax rates, which reached 94% in the mid-20th century, have been much lower since the Reagan tax cuts. The complex and ever-changing tax landscape is one reason all investors can benefit from the advice of a trusted financial advisor.
With concerns over a new federal budget, the debt ceiling, tax policy, and the presidential election, how can investors maintain perspective as political events unfold? The reality is that the stock market has performed well despite political and fiscal challenges in Washington. This has been the case during election years, when different political parties are in power, and even during fiscal crises. With the benefit of hindsight, making portfolio decisions in response to news on these issues would have caused investors to miss the entire bull market beginning in 2009, the strong rally following the pandemic, last year's market rebound, and more.
The bottom line? Investors should focus on their financial plan and maintain a diversified portfolio rather than reacting to daily Washington headlines. Sticking to a financial plan designed around long-term goals and tax considerations is still an excellent way to work toward your financial success confidently.
Pursuit Planning and Investment, LLC is a fee-only fiduciary financial planning firm in Portland, Oregon. We sign a fiduciary oath and do not receive a commission for selling products. We offer virtual financial planning services for working professionals. Feel free to review our services and place a commitment-free 30-minute discovery meeting on the calendar. Plan your pursuit!
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