April 5, 2021
Paul Christopher, CFA, Head of Global Market Strategy
Gary Schlossberg, Global Strategist
What the president’s latest fiscal proposals may mean for investors
Key takeawayscall out
- President Joe Biden has proposed an eight-year, $2.25 trillion spending package built around $1.7 trillion investment in infrastructure, physical assets, and research and development. Partial financing comes from a series of proposed corporate tax increases approaching $2 trillion over the next 15 years.
- At this point, we anticipate that Congress will combine both parts of the spending and tax proposals and run them through the budget reconciliation process.
What it may mean for investorscall out
- It is too early to conclude what the spending amounts and final tax provisions will ultimately be. We also note our expectation is that the tax provisions are unlikely to be retroactive but will begin as of January 1, 2022. We believe our current tactical portfolio preferences are consistent with additional spending and some of the tax measures that we present below.
As expected, the president has proposed a $2.25 trillion spending package over the next 8 years built around $1.7 trillion investment in infrastructure and other physical assets along with research and development. Partial financing comes from a series of proposed corporate tax increases approaching $2 trillion over the next 15 years.
Highlights of the plan are as follows:
Last week’s proposal was the first of a two-part package, to be followed soon by a second spending proposal of up to $2 trillion focused on education, health, and child care. That part of the president’s proposal will be accompanied by personal tax hikes. High on the list of measures reportedly included is an increase in the top personal income-tax rate from 37%to 39.6%. Other proposals will likely include a higher top tax rate on capital gains and changes to the estate tax.
The president may stay with his campaign proposal to tax capital gains at the ordinary rate (proposed at 39.6%), though the final bill could simply raise the rate from the current 21% to a 28% rate viewed as a sweet spot for maximizing revenues. Other provisions will probably include higher estate taxes and, possibly, an increase in the tax rate from 40% to 45%, a reduction of individual tax and gift exemptions from the current $11.7 million to $3.5 million, and — perhaps — a more controversial elimination of the step-up in basis for reducing capital gains subject to the estate tax.
Looking aheadcall out
At this point, we anticipate that Congress will combine both parts of the spending and tax proposals and run them through the budget reconciliation process, which requires only a simple majority vote to pass in the Senate.1 That means another partisan bill that the administration and congressional leaders are prepared to run through with a narrow majority in the House and a tie-breaking vote in the Senate by Vice President Kamala Harris. The razor-thin majority in both Congressional chambers leaves the president’s proposal open to plenty of horse trading — even within the Democratic Party — to maintain that majority. Among the most likely changes is an effort by high-tax states to eliminate the $10,000 cap on state and local tax deductions.
Under the best of circumstances, the House is aiming for a July 4 vote for their version of the bill, followed by a Senate debate and passage before the summer recess now scheduled for August 9. More likely is a Senate vote sometime after the return from summer recess scheduled for September 10.
Investment implicationscall out
The process of debate and discussion in Congress routinely subjects provisions from the original submission to delay, dilution, and deletion by the time the president signs the final bill into law. Those provisions that we believe have the highest probability of eventual passage include the higher corporate tax rate and the GILTI rate, as listed in the table on page two. Also, we believe that an increase in the top personal income tax rate to 39.6% and an increase in the capital gains rate to 28% (for taxpayers whose annual income exceeds $1 million) are likely to pass. However, the negotiating process and, ultimately, the thin majorities in Congress may limit the measures beyond these. Moreover, we do not expect new tax provisions to become effective until January 1, 2022.
The latest round of fiscal support to the economy is fully consistent with our current portfolio preferences, which focus on small cap equities and other economically sensitive sectors that include industrials and materials producers. We are also maintaining our favorable view of technology and social media, whose post-pandemic opportunities will likely be enhanced by growth underpinned by increased government spending and, more specifically, by proposals to upgrade and expand broadband and other tech-related investment. Stronger economic growth strengthens the case for a focus on yield-advantaged sectors of the market — like preferred and municipal securities — rather than reaching for yield by moving into longer-term Treasury securities.2
1For more on how the budget reconciliation process works in Congress, please see our report Policy, Politics and Portfolios: Budget Reconciliation Is a Key for Financial Markets, March 30, 2021.
2For a discussion of most recent tactical preferences, please see our report, Adjusting guidance for a stronger 2021 growth outlook, March 5, 2021.
Risk Considerationscall out
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Small-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. Municipal bonds are subject to credit risk and potentially the Alternative Minimum Tax (AMT). Quality varies widely depending on the specific issuer. Municipal securities are also subject to legislative and regulatory risk which is the risk that a change in the tax code could affect the value of taxable or tax-exempt interest income. Preferred securities have special risks associated with investing. Preferred securities are subject to interest rate and credit risks. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer's capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue may be callable which may negatively impact the return of the security.
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