Since becoming US president, Joe Biden has announced an eye-watering US$6 trillion in proposed fiscal spending. First was the US$1.9 trillion American Rescue Plan in January. All those US$1,400 stimulus cheques are still reverberating through the economy as consumers unleash pent-up spending power.
In the past two months, there have been two further very large proposals: the American Jobs Plan (US$2.3 trillion), focused on rebuilding much of the country’s ageing infrastructure, and the more recent American Families Plan (US$1.8 trillion), aimed at funding childcare and education.
These are massive numbers in both absolute and relative economic terms. They come at a time when politicians and markets are more tolerant of higher levels of debt to fund spending habits.
However, the choice to fund these stimulus packages through higher corporate and personal taxes may take a toll on US equities. The difficulty lies in assessing what the final policy mix will actually look like.
The plans announced so far are unlikely to look exactly like the policies ultimately agreed upon. Democrats generally approved of the measures in the huge American Rescue Plan that were paid for by increasing government debt.
However, the proposals to fight climate change, build infrastructure and fund education by imposing higher taxes on companies and wealthier households are unlikely to find the same broad-based support.
Given the magnitude of Biden’s policy agenda and the slim Democratic majority in the Senate, the current proposals are likely to be scaled back. As such, the proposed increase in the corporate tax rate from 21 per cent to 28 per cent may end up being closer 25 per cent.
In addition, the global corporate minimum tax rate, if agreed to internationally, is likely to be lower than the current favoured rate of 21 per cent.
Even if the proposed tax rates are not met, any increase could create a drag on corporate earnings. Further, the proposal to raise capital gains tax for those earning over US$1 million would dent equities if it leads to selling pressure, if wealthy investors try to avoid new taxes or reduce their after-tax expected returns.
Congress holds the purse strings – not the president – and Biden faces procedural limitations. It’s unlikely that the increase in spending and the taxes to pay for it would gather the requisite 60 Senate votes. This means reverting to the budget reconciliation process, which only requires 51 votes.
The rub is that the reconciliation process is also budget neutral. Any changes to the planned spending must be equal to the expected change in revenues over the 10-year forecast period. That’s a hurdle for the current proposal which expects to pay for eight years of infrastructure spending with tax increases over a 15-year time frame.
Senate Majority Leader Chuck Schumer stands and applauds with others as US President Joe Biden addresses a joint session of Congress on April 28 in the House Chamber at the US Capitol in Washington. Photo: Washington Post
Despite all the challenges to both the size and scope of the current spending packages, and how they are to be funded, there is still a good chance that changes to tax legislation for both corporate income tax and capital gains taxes will be passed in some form before the end of the year.
Investors are right to fret over tax increases reducing corporate profits, impinging on equity returns in the coming year. Taking into account the various tax proposals, and the offsetting impact from the positive effects on economic growth and earnings from the infrastructure spending, it’s estimated that Biden’s fiscal plan could reduce corporate earnings by 4-5 per cent in 2022.
However, this drag on earnings growth comes at a time when companies are experiencing a robust economic and earnings recovery, which should create some ability to absorb a potential tax increase.
Shoppers leave a clothing store in Hialeah, Florida, on April 13. US$1,400 stimulus cheques are still reverberating through the economy as consumers unleash pent-up spending power, but new taxes could hurt corporate earnings. Photo: Bloomberg
The Tax Cuts and Jobs Act signed by former US president Donald Trump in 2017, which reduced individual and corporate tax rates, benefited some sectors more than others. The same will be true of any tax increase. Technology, communication services and health care sectors may experience a larger impact as tax loopholes are closed on foreign earnings.
In contrast, industrial, energy and materials sectors stand to gain from the spending aimed at increasing America’s infrastructure capacity and green energy network.
Overall, without a clear indication of the size, scope or time frame for implementing spending and tax policies, it’s hard to imagine that markets are adequately reflecting what an increase in taxes is likely to mean. This will remain a big open question for capital markets. Watch this space.
Kerry Craig is a global market strategist at JP Morgan Asset Management