How the Election May Impact Policy

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. The election is less than a month away. Here with me today to discuss some of the key policy issues that the next administration will be likely to address is Aron Szapiro. Aron, is Morningstar's director of policy research. Aron, thanks for joining me today.

Aron Szapiro: Thanks so much for having me.

Dziubinski: Now, you've said that the election will really determine the next move in this sort of ongoing battle over the regulating of financial advice. Before we get into that, let's step back a little bit and talk about where we are today. Regulation Best Interest did go into effect this year, right?

Szapiro: That's right. Regulation Best Interest went into effect on June 30 of this year. That regulation only applies to broker/dealers. The increased disclosure is applied both to broker/dealers and registered investment advisors, and it does aim to at least somewhat mitigate conflicts of interest in sales, although it doesn't have bright line prescriptions for the most part around how to mitigate those conflicts of interest. Now the other thing that's happening right now is the Department of Labor has re-proposed a fiduciary rule that would apply both to broker/dealers and registered investment advisors, but only if they're giving ongoing advice--there is an ongoing relationship--so we'll see where that proposal goes.

Dziubinski: Given the variety of different election outcomes that we might see, what do you expect the next steps to be there?

Szapiro: In one possibility, Biden unseats Trump as president but does not control the Senate, and then he can really only do things, of course, through the executive branch. We'd expect a fair amount of gridlock, certainly on these issues, where the parties are pretty far apart. But there could be quite a bit of change there. The composition of the SEC would flip to being 3 to 2 in favor of Democrats based on Biden's appointees. And there's a lot of movement to enhance the standards of Regulation Best Interest, perhaps really align them. The broker/dealer standards of conduct with those of registered investment advisors, and maybe elevate all of those standards. So, I think you'll at least see a real effort to do that. And then, of course, the Department of Labor would be--you know, it's an executive branch agency--and so I think you'll see probably a much stronger rule. That said, without Congress acting and amending ERISA, you know the department doesn't seem to have the kind of authority that they were asserting in 2016 over the IRA market. That's what the courts have said. And so without clarity there, there's limits to what they can do. Now if, there's a new president and a democratically controlled Senate and a democratically controlled House, you might see bigger changes. Although I don't imagine this is going to be at the very top of the policy agenda.

Dziubinski: Let's pivot now to talk a little bit about sustainable investing and the election. You noted in a recent column that the election will really have concrete consequences for the future of sustainable funds and sustainable strategies. What do you mean by that?

Szapiro: The Department of Labor--well, let me just preface this by saying, I do think that the sort of secular momentum is toward more and more investor interest in sustainable investing, in funds that use different kinds of ESG factors in their security selection. I don't think that's going to change the investor interest, but you know, certainly the flows at least inside 401(k) plans, at least over the next couple of years, could really be determined by this election. The reason for that is the Department of Labor has drafted a rule that would make it extremely difficult to offer what they call "ESG mandate funds." And there's not a clear definition there. Inside 401(k) plans, they would not be able to be offered as qualified default investment alternatives. That's the way most people find their way into an investment, and there'd be a really high bar for even offering them as a designated investment alternative. So, very clearly this rule will either be--will just never see a finalization or will be substantially altered in a followup rulemaking, if Biden were to win. Otherwise I think it's going to blunt the momentum at least inside 401(k) plans, at least for a while.

Dziubinski: Speaking of 401(k)s, Joe Biden has laid out a plan for them. Can you give us give us the gist of that?

Szapiro: I can try. All I can really do is give the gist because it's a very high-level plan, but what he wants to do is replace the current tax benefit, where people make the contributions prior to paying taxes with the exception of FICA taxes and therefore get a benefit that is based on their marginal tax rate. The highest tax rate you pay in a progressive system, right? So, it's on the last dollar earned. What he wants to do is replace that with a flat credit. So, everybody gets the same amount. Now I have to say the devil is really in the details here. If that flat credit is something like 26%, which I take it from outside analysis is what would be roughly revenue-neutral, you know, I think that obviously benefits lower income people whose marginal rate might be 12%, so they're getting more money for contributing than they otherwise would. It hurts people whose marginal tax rate is above that. That's not that many people. It's probably fine. But credit starts to get lower, either because they're trying to make it refundable or what have you. It might discourage employers from offering plans. We're trying to think about ways we can analyze that. It's hard to do. I mean, there's not like a good natural experiment there.

The other feature of this plan that we think is part of it, although it's not that clear, is that the government tax benefit would go directly into the retirement plan. And I think this is a really good idea. It essentially makes the tax break like a government match. You know, I think people are fairly inelastic in changing their rate of contributions. I mean, basically, what you'd see is, you know 26% more or whatever that number is going into retirement savings and ultimately that money would be taxed when it was withdrawn. So, this is not a bad deal for the government, and it's probably not a bad deal for ordinary people, so we'll see where that goes. But I do think the devil is in that detail--the detail of how big that flat credit is, I think, it really does matter in terms of incentives.

Dziubinski: Well, Aron, thank you so much for your time today. We appreciate it.

Szapiro: Thank you so much for having me.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.