Balancing Campaign Promises With Economic Realities

MIKE TOWNSEND: The 2024 election will go down in history for any number of reasons. The latest withdrawal of a candidate for a major party in modern history. The estimated $11 billion spent on advertising alone. Two assassination attempts. Two parties whose strategy often seemed to consist solely of stoking fear in voters about the other party and its plans. But in the end, the 2024 election worked. Fears of election interference, of fraud, of a disputed election, of weeks of uncertainty about the outcome did not come to pass. More than 150 million Americans cast ballots in a free and fair election. And the markets loved it.

The Dow Jones Industrial Average and the S&P 500^® both had their best week of 2024. The Russell 2000® small-cap index had its best week in more than four and a half years. Whether your preferred candidate won or lost, the focus now turns to how the new administration and the newly elected Congress will address a host of thorny policy issues. From taxes and tariffs to debt and deficits to regulations and geopolitical challenges, the decisions made in the year ahead will have profound implications for investors, for the markets, for the economy, and for the American people. 

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to.

Coming up in just a few minutes, I'm going to offer my thoughts on the election and the implications for investors of some of the key policy issues that loom in 2025. But first, three quick updates from Washington on non-election issues. 

First, the Federal Reserve met last week and, as expected, decided to lower the target range for the federal funds rate by 25 basis points. The Fed's next meeting is December 17 and 18, and the market will be watching carefully to see whether the Fed takes a pause in the rate-cutting cycle. The Fed, of course, is very data dependent, and there'll be plenty of economic data released between now and then for the Fed to sift through. 

According to CME's FedWatch tool, which is a great resource for gauging the market's expectations for Fed rate moves, the chances for a December rate cut went from 83% on November 1 to 59% on November 12. But more notable is that on November 12, the chances of a rate cut at both the December and January meetings is less than 30%. The consensus seems to be that a pause is coming. It's just not clear whether it will be in December or January. But the piece of Fed day last week that really captured my attention came during Chair Jerome Powell's news conference. He was asked whether in the wake of President-elect Donald Trump's victory, he would resign if asked. And he responded with one word: "No." Later, he was asked about whether Trump could move to fire him or other Fed governors, and he responded with five words: "Not permitted under the law." 

All of this stems from Trump's comments during the campaign about wanting more of a voice in monetary policy decisions. Trump's issue with Powell, whom it's important to remember he nominated as Fed chair, dates back to the 2018 to 2020 period when he was frustrated that first Powell was raising rates and then that he wasn't cutting rates fast enough. He called Powell and the other Fed governors "boneheads" in 2019 and called Powell an "enemy of America" in 2020. Now Trump himself has backed away from the idea of trying to fire Powell before his term as chair ends in May of 2026. Some in Trump's orbit have speculated about firing Michael Barr, the Fed vice chair for supervision, whose role includes overseeing regulation of banks. But trying to fire any of the Fed governors seems unlikely to me. It would inevitably trigger a long drawn-out court challenge, one that, as was clear from Powell's short comment at last week's news conference, the Fed is confident it would win.

But Trump will have the ability to nominate a new Fed governor in early 2026, when Adriana Kugler's term expires, and then a new chair later in 2026 when Powell's term expires. So he may be content to wait for those opportunities. There's also talk in Washington that he may nominate Powell's successor a year or more in advance, creating a kind of shadow chair that he could use to push a different message than Powell is pushing.

This is all part of a broader discussion about the Fed maintaining its long-standing independence. The Fed guards this independence zealously, but some are concerned that Trump may try to undermine it. It's a topic I've been getting asked about by investors a lot recently and one that will likely continue to be part of the discussion throughout 2025 as the Fed navigates a complicated economic situation amid a new Trump administration. 

Second, Congress is back in Washington for what is known as the lame-duck session. Post-election sessions of Congress always have very strange dynamics, and this one is no exception. 

This week is also orientation for newly elected members of Congress, and each party is holding leadership elections for the next two years. That means that outgoing members of Congress, those who are retiring or who just lost their re-election races, are side-by-side in the Capitol with their successors. Talk about awkward. But the old Congress does have some substantive work that it needs to focus on. Although I suspect most of that work will take place after Thanksgiving. Lawmakers want to replenish disaster relief funds at both the Small Business Administration and the Federal Emergency Management Agency, or FEMA, after this fall's hurricanes. And Senate Democrats will be pushing to confirm as many of President Biden's judicial nominees as possible before they lose their majority at the end of the year. But the bigger issue is the looming expiration of government funding.

Congress still has not passed any of the 12 appropriations bills that fund every federal agency and government program for the fiscal year that began back on October 1. They passed a temporary extension of funding in late September that keeps the government open and operating through December 20. So that's the new deadline. And there are a couple of paths forward here. One, and probably the most likely, is that Congress will pass another temporary extension of funding and punt the whole issue to the new Congress that convenes in January. Some Republicans are eyeing a March deadline to give the new Congress and new administration a few weeks to settle in before confronting the issue. There are some Republicans who would like to pass the appropriations bills and finalize the current year's funding before that December 20 deadline so that the issue is not on the table when the new Congress takes over in January. They want to clear the decks for President-elect Trump to take office without having a new funding deadline looming right off the bat. But that's not likely to happen, particularly because the Senate, for now, is still controlled by Democrats who probably aren't too eager to help out the Republicans. 

Finally, on the last episode, I talked about some of the key announcements from the IRS about taxes in 2025. The one thing we were waiting for was the 2025 retirement savings contribution levels. Now we have that information. For (401)k and other employer-sponsored retirement plans, the contribution limit will rise from $23,000 in 2024 to $23,500 in 2025. The catch-up contribution for individuals 50 and over will not change. It will be $7,500 again next year. Put that together, and savers 50 and over can save a total of $31,000 in their plan next year. 

But there is also a new wrinkle, courtesy of a provision of the Secure Act 2.0, the retirement savings law that passed Congress at the end of 2022. That law created what's become known as the super catch-up contribution. For workers aged 60, 61, 62, and 63, and only workers who are those ages, there is an additional catch-up contribution of $3,750 that will be permitted beginning next year. One other thing to note, there will be no changes to the contribution limit for individual retirement accounts, or IRAs. That will remain at $7,000 in 2025, plus an additional $1,000 catch-up contribution for workers 50 and over. There's no super catch-up for the IRA holders. Now that's a lot of numbers, so we'll put a link to the IRS press release in the show notes. 

On my deeper dive today, I want to explore the four policy issues that I think will be most relevant for investors in the context of last week's election outcome. But first, just a quick reminder on where things stand in the battle for control of Congress. In addition to President-elect Trump's sweeping victory in both the Electoral College and the popular vote, Republicans, as expected, flipped the Senate. They needed to flip just two seats to capture the majority, and they ended up winning four—in Montana, Ohio, Pennsylvania, and West Virginia, giving the Republicans a 53 to 47 margin in the Senate next year.

But Democrats were able to hold on to four Senate seats in states that Trump won, including Arizona, Michigan, Nevada, and Wisconsin. This kind of ticket splitting between the presidential race and the Senate race has become increasingly unusual. It happened just once in 2020 and not at all in 2016. 

Turning to the other side of the Capitol, as I record this, we still do not have official results in the battle for the House of Representatives due to the slow counting process in some very close races in California and a handful of other locations. But it seems clear at this point that Republicans will emerge with a tiny margin of one to five seats in the House. 

That close margin in the House will be really interesting to watch over the next two years and a potential stumbling block on some issues. It's essentially the same size majority that Republicans have had in the House over the last two years, a Congress that will go down in history as the least productive in terms of legislation passed. House Republicans struggled over the last two years to remain on the same page, leading to unprecedented situations like the 15-vote marathon in January 2023 to elect a speaker, followed nine months later by the ouster of that same speaker. 

While most House Republicans in 2025 will be Trump loyalists, the margin is likely to be so small that just a few lawmakers who don't go along with the party line on a particular vote will cause a lot of problems. It will also make attendance important, as Republicans won't be able to afford many absences and still be able to pass their agenda. One looming complication is that Trump has already indicated that he will tap two sitting Republican members of Congress for Cabinet or other high-level posts in his administration. If he follows through, those lawmakers will have to resign from the House, and their seats won't be filled for several weeks until special elections can be held. In a razor-thin House majority, two or more temporary vacancies could be problematic on some key votes. 

With the election mostly in the rearview mirror, markets and investors are beginning the process of parsing out the potential impact of some of Trump's policy proposals, from lower taxes to higher tariffs to an immigration crackdown and much more. But the market has a long history of responding positively to an election simply being over. In fact, in the last 50 years, the market, as represented by the MSCI All Country World Index, has only gone down in the period from Election Day to Inauguration Day twice―once after the 2000 election and once after the 2008 election. In both cases, the economy was in recession, and a bear market was already underway. Generally, global markets cheer the end of a U.S. election. 

President-elect Trump and his team have pivoted quickly to the transition process. 2025 in many ways should be viewed as the beginning of year five of the Trump presidency rather than year one of a new presidency. Trump's transition in 2016 was chaotic and disorganized. It took months for him to pick people to fill key positions and get them confirmed by the Senate. There are about 4,000 government positions that the president needs to fill, with about 1,200 requiring Senate confirmation. In 2016, he did not have a ready-to-go list of people to fill those jobs, and he did not have a ready-to-go list of policy priorities.

That won't be the case this time. His team has spent months vetting loyalists to fill positions as quickly as possible and has reportedly prepared more than 250 executive orders for him to sign on day one or soon after on everything from immigration to the federal workforce to climate change and environmental issues to tariffs. 

No incoming administration executes the transition perfectly, of course, but the four years of experience that Trump already has in the White House and the better preparation of the team around him means he's much more likely to hit the ground running this time than he was the first time around. And that's important because 2025 is shaping up as one of the most consequential years from a policy standpoint in a long time. The combination of several statutory deadlines on issues like taxes and the debt ceiling, plus the priorities of an incoming administration that is likely to have a unified Washington, sets up for a dizzying series of policy debates next year that will have far-reaching consequences for investors, companies, and the markets. 

At the same time, the policy agenda will be complicated by the promises Trump made on the campaign trail. In this he's no different than any other candidate. All candidates make a lot of promises during a campaign. But the gap between campaign promises and those promises becoming law is an enormous one. Like all incoming presidents, Trump will undoubtedly be forced to cast aside some of those promises, to compromise on one thing in order to get another thing passed, to cut deals, and to acknowledge that he can't do everything. And he'll need to balance those promises with the cost to the economy and the very real concern of reigniting inflation. Moreover, there is no predicting what geopolitical, economic, and monetary factors might occur in 2025 and beyond that could alter his priorities. So with that backdrop, here are the four policy issues that I think will most affect investors next year. 

Issue number one is tariffs. Over the course of the campaign, President-elect Trump never wavered in his enthusiastic support of tariffs. At one point calling "tariff" his favorite word in the English language. Tariffs have been around forever, and certainly other presidents have utilized them, including Joe Biden. The difference now is the depth and breadth of the Trump plan. He has called for a 10 to 20% across-the-board tariff on all imports, a 60% tariff on Chinese imports, and a few one-off ideas like a 200% tariff on cars imported from Mexico. The result would be the highest tariffs on foreign goods in nearly a century. His ability to do this unilaterally is not crystal clear, but Congress has granted wide latitude over the years to the chief executive when it comes to imposing tariffs. And a Republican Congress in 2025 may be inclined to include tariffs as part of a larger tax package anyway, erasing any doubts about the administration's ability to put them in place.

But many economists believe Trump's tariff proposals carry significant economic risk. Tariffs are usually passed on to consumers in the form of higher prices, which could trigger another round of high inflation and slower economic growth. Trump will have to reckon that with his promises to reduce inflation and specifically lower prices for goods. Tariffs could also instigate a global trade war, with other countries slapping similar tariffs on U.S. exports. Last month, the International Monetary Fund, or IMF, forecast that U.S. GDP would slow by about 0.4% if across the board 10% tariffs were imposed and other countries responded in kind. But the IMF did not model all scenarios. Other economists have concluded that if the 60% tariff on China and a higher across-the-board rate of 20% are included, the hit to U.S. GDP becomes more significant, approaching 1.5%. In Washington, there's long been a sense that any tariffs the Trump administration may impose will fall well short of his plan to put a tariff on, well, absolutely everything.

More likely, they'll be used as a negotiating tool as Trump seeks to work agreements with other countries to lower their trade barriers. If that's the case, then the impact of tariffs on the U.S. economy, prices, and inflation may well be less than is projected. 

A key to all this will be how China reacts to additional tariffs. The United States remains China's largest foreign market, and steep levies could have a material impact on China's economic growth at a time when its economy is already in a precarious state. During Trump's first term, tariffs brought China to the negotiating table, and the two countries signed an agreement. But China did not live up to its end of that agreement, casting doubt about its reliability. China's weakened economic state this time around may bring it back to the negotiating table, but it also makes China less predictable. When it comes to tariffs, the specifics are important. The amount of the tariff, which imports they apply to, the countries targeted, and how those countries respond, all will be critical factors in what the broader economic impact will be. The markets will be keeping a close eye on whether the reality of tariffs matches the president's campaign rhetoric. 

The second big issue and one with an even more direct impact on investors is taxes. I've been talking for a long time about how the biggest policy issue in 2025 will be taxes. And the catalyst is the fact that all of the 2017 tax cuts that were approved during the first year of the first Trump administration are set to expire at the end of 2025. That includes lower individual income tax rates, higher standard deduction, the higher amount of assets that can be inherited without triggering the estate tax, and dozens of other provisions. If Congress does nothing, all of these provisions will expire at the end of next year and, beginning in 2026, revert to their pre-2017 levels. The top income tax rate, for example, would go from 37% back to 39.6%, and most of the other tax rates would also change.

The estate tax exemption amount, which is slated to be $13.99 million per person in 2025, would be cut in half. Regardless of the election outcome, this was always going to be a tricky issue for lawmakers. But if Republicans retain their majority in the House, they'll be able to move quickly to extend these expiring provisions by using a process called budget reconciliation.

This is a parliamentary procedure that expedites consideration of tax issues in Congress and crucially allows them to be passed with a simple majority, bypassing the need for a 60-vote supermajority in the Senate. It's how the 2017 tax cuts were originally passed in the first year of the previous Trump administration. And it was used during the Biden administration to pass the Inflation Reduction Act. It only works if one party controls the White House, the Senate, and the House of Representatives. Using budget reconciliation means a tax package could be considered and passed quickly in the new Congress, probably in the first or second quarter of 2025. But the details still have to be hashed out among Republicans. The plan is likely to extend all of the expiring provisions, a move that on its own is estimated to cost $4.5 trillion, according to the nonpartisan Congressional Budget Office.

And that's before considering all the other tax changes that Trump proposed on the campaign trail. He called for an end to the taxation of tip income, of Social Security benefits, and of overtime hours. He wants to see a corporate tax cut. He proposed making the interest paid on auto loans tax deductible, like mortgage interest. And he's called for eliminating the $10,000 cap on the state and local tax deduction, a cap that was part of his own tax bill in 2017.

Adding these to the tax bill next year would take the cost above $10 trillion, according to the Committee for a Responsible Federal Budget, a Washington, D.C., think tank, increasing the budget deficit and the national debt. Even adding the most ambitious estimates of revenue gained by imposing all of his tariff proposals, which some analysts have pegged at about $3 trillion, would only make a relatively small dent in the overall fiscal impact of the plan.

There are many deficit hawks among House Republicans for whom a tax cut proposal that only increases the deficit would likely be unpalatable. So expect some compromises to be made, some items to be dropped. Eliminating the tax on tip income appears to have some real momentum in Washington. Even Kamala Harris supported the concept in her campaign. But others, like eliminating taxes on Social Security benefits, may just have a price tag that is too high.

One to watch is eliminating that $10,000 cap on the state and local tax deduction, a proposal that has passionate supporters among lawmakers who represent high-tax states like New York, New Jersey, California, and Illinois. But the cost in terms of revenue lost is enormous. And there are many Republicans who represent states like Oklahoma or Kansas, just to name a couple at random, where this is just not an issue at all. One idea gaining some momentum is doubling the cap from $10,000 to $20,000 for married couples as a way to provide some relief without adding as much to the federal deficit. The coming tax debate is going to be a complex and ever-evolving one. I'll be following this as closely as anything in 2025.

The third issue is the debt ceiling, which I feel is the one that is not getting the attention it deserves. The debt ceiling is the cap put in place periodically by Congress on the total amount of debt the United States can accumulate. The debt ceiling was suspended in mid-2023 as part of a bipartisan deal. The law suspending it says that the debt ceiling will return on January 2 of 2025 at a level expected to be north of $35 trillion.

At that point, the United States will not be able to accumulate any more debt until the limit is raised. The Treasury Department can use cash on hand to pay its obligations, and it can take what it calls extraordinary measures, a series of steps to avoid defaulting on our debts. But those steps are temporary and typically buy Congress only three to six months. Congress will have to raise the debt ceiling by mid-2025.

Doing so is always a controversial and difficult vote on Capitol Hill because it's not about getting the federal debt under control. It's about literally increasing the amount of debt. It draws attention to the staggering size of the nation's debt and the inability of lawmakers to manage it. 

In 2025, the responsibility for raising it will fall to Republicans if they have unified control in Washington. But in 2023, 71 House Republicans voted against the debt ceiling increase. There's a small handful of Republicans who have never voted for a debt ceiling increase. Usually, it takes a mix of Republicans and Democrats to vote for a debt ceiling increase in order to pass it in the House. But having been relegated to the minority in Washington, Democrats are unlikely to want to do the majority any favors. Markets do not like the uncertainty surrounding when and whether Congress will increase the debt ceiling. Market volatility historically increases as the deadline for a potential default approaches. The United States has never defaulted on its debts, but it came the closest it ever has to doing so during that 2023 debt ceiling debate. A repeat of coming right to the brink of default could be in the cards in mid-2025. It's definitely something for investors to keep an eye on.

And my fourth and final policy issue is―welcome to the era of deregulation. The president-elect has said that deregulation will be a top priority of his administration. There are various ways that deregulation can take place. The president can use executive orders to unwind some policies or direct an agency to ignore or not enforce a rule or change a position held under the previous administration. Congress can also play a role using something called the Congressional Review Act to overturn rules that were recently imposed by the previous administration. There's a time limit involved in this procedure, so it really only applies to rules put in place during the final months of the previous administration. It requires a simple majority vote in both the House and the Senate to void a rule. During Trump's first presidency, Republicans had full control of the House and the Senate in 2017, and they used the Congressional Review Act 16 times to overturn rules put in place near the end of the Obama administration. In 2021, Democrats had full control of Washington and used the procedure five times to overturn rules the Trump administration had approved. Congress can also just pass laws that overturn or override previous regulations, but that's done via the regular legislative process, so it's slow.

Finally, regulatory agencies themselves change rules all the time through the ordinary regulatory process. But this, too, is time consuming, as it requires an agency to propose a new rule that overrides the previous rule, go through a lengthy public comment process, followed by a review period of those comments before the agency can finalize the new rule. Here's a great example of that process. During the Obama administration, the Labor Department finalized a rule that would allow retirement plans to consider environmental, social, or governance factors when choosing investment options for the plan if all other factors were similar. The first Trump administration came in and unwound that rule, prohibiting retirement plans from considering ESG factors. Then the Biden administration undid that rule and went back to a rule similar to the Obama administration's. Now, with Trump 2.0 coming into office, that rule is once again a target for being overturned. All of this makes it hard for companies to plan for the long term because the rules seem to change every time there's an election. 

But there is an additional complication that will have unpredictable effects on the Trump administration's regulatory or deregulatory agenda, the courts. Last summer, the Supreme Court overturned a standard known as the Chevron Doctrine that had been in place for 40 years. In a nutshell, the Chevron Doctrine said that courts had to defer to the expertise of regulatory agencies when they wrote rules to interpret a vague law from Congress. That deference no longer applies. What it's likely to mean is that many, perhaps most, regulations will face legal challenges and ultimately be decided by the courts. It's likely to be a confusing and time-consuming process that will leave many regulations in limbo for months or longer.

In 2025, numerous regulations are likely on the chopping block, and the financial services sector is likely a prime target. Big banks are anticipating that proposed rules requiring them to hold more capital won't come to fruition, and that changes to the stress-testing process are also likely. Banks of all sizes are likely to see the easing of new rules around mergers and acquisitions. At the SEC, a change in leadership will result in the shelving of proposed rules regarding how stock trading works and the use of predictive data analytics when providing investment advice. Rules requiring more disclosure about the risks companies face from climate change, already being challenged in the courts, are also likely to fade away.

And one of the biggest winners of the election may be the cryptocurrency industry, which is sure to come out from a series of lawsuits and other enforcement actions from an anti-crypto SEC and find itself with a much friendlier audience at both the SEC and on Capitol Hill. Other parts of the economy are also likely to see significant impact from a lighter regulatory touch. Trump campaigned on easing regulations in the health care sector and rolling back environmental-friendly rules like the Biden administration's emissions reductions for power plants and incentives to boost electric vehicles. 

In 2025, companies will have to take into consideration a lot of competing narratives about the impact of government policy on the business environment generally. On the one hand, a corporate tax cut and sweeping deregulation would be a big win for companies. But tariffs could force companies to raise prices and face a backlash from consumers. And mass deportations and other changes to immigration law could reduce the number of available workers, particularly in areas like construction, agriculture, and hospitality. What the net effect will be on the economy depends a lot on the details of all these policies and more. 

My goal with this podcast in 2025 is to explore these issues more deeply as the policy debates unfold. I'll be your eyes and your ears as Washington undergoes a profound shift in direction.

Well, that's all for this week's episode of WashingtonWise. We're going to take a break for the Thanksgiving holiday. So our next episode will be out in a month, December 12. I'll be focusing on the 2025 outlook for equities and the economy. 

Take a moment now to follow the show in your listening app so you get an alert when that episode drops, and you don't miss any future episodes. And I'd be so grateful if you would leave us a rating or a review. Those really help new listeners discover the show.

For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript. I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, have a very happy Thanksgiving, and keep investing wisely.