One of the biggest debates in markets right now is over precisely what effect America’s $1.9trn coronavirus stimulus package will have on growth, inflation and debt levels.
Yet US president Joe Biden is already looking to the next level. This week – tomorrow, in fact – he plans to unveil a $3trn “Build Back Better” proposal, which includes his flagship infrastructure vision and much more. But what exactly does it involve? And what might it mean for your money?
The plan will be split into two legislative proposals, White House Secretary Jen Psaki said on Sunday. The first part of the plan – the part that’s due to be officially unveiled on Wednesday – will deal with Biden’s infrastructure and investment vision. This will include investments in clean energy, manufacturing, 5G mobile technology – all the “on-trend” sectors.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Meanwhile, the second part of the plan – to be announced in a few weeks – is being touted as the “social infrastructure” section. This includes proposals for free community college and universal pre-kindergarten, according to the New York Times, as well as moves to increase the participation of women in the workforce.
The political logic behind the split is pretty self-explanatory. Prioritising the “roads and bridges proposal” (as it’s been nicknamed), will make it easier to get Republican backing. Given the razor slim-majority Democrats hold in the Senate, that matters. Combined, the two proposals add up to more than $3trn more in public spending.
At least $1trn will be earmarked for building and repairing physical infrastructure with a focus on climate change, says the New York Times. Biden’s election campaign pledges also emphasised a shift towards renewable energy and electric vehicles.
The proposals are likely to be funded by tax rises
The idea of investing in improving and upgrading America’s infrastructure (physical infrastructure, at least) is one of the rare things that both Democrats and Republicans agree on. However, the sticking point is also clear: how will it be paid for?
During the election campaign, Biden proposed some tax rises to at least partly fund these proposals. And both White House Secretary Jen Psaki and Treasury Secretary Janet Yellen reiterated this view last week. But what sort of taxes are we talking about?
Biden campaigned for raising corporate taxes from the country’s current level of 21% (corporation tax was lowered under Donald Trump) to 28%. Other measures include increasing the top tax rate for the richest income bracket from 37% to 39.6% as well as increasing capital gains taxes on millionaires. He has, however, also pledged that households bringing in less than $400,000 a year will not be paying more in any federal taxes being pencilled by the White House. Whether or not that turns out to be true is another matter.
Officials are also looking at where cuts could be made in other areas. One idea is to have Medicare, America’s national health insurance programme, negotiate the cost of prescription drugs direct with pharmaceutical firms. Officials are also looking at whether to extend some 2017 tax breaks on business investment – due to expire soon – to woo industry.
Will the plan be approved?
Of course, we’ve had American “infrastructure weeks” coming out of our ears – Trump notably kept talking about it but it never came to anything. So will this make it any further than the drawing board?
Getting bipartisan approval for the plan certainly won’t be easy. Republicans strongly oppose tax rises, suggests Aric Newhouse, the National Association of Manufacturers’ senior vice president for policy and government relations. “That’s the kind of thing that can just wreck the competitiveness in a country,” he says. And Newhouse is not alone. Senate Republican leader Mitch McConnell has described the plan as a “Trojan horse” for huge tax rises.
However, the Democrats do have a majority – it might be a slim one, but the proposals could potentially be approved without Republican support, just as the $1.9trn rescue plan was. The latter was funded by federal borrowing in a process known as “budget reconciliation”, which is a way of garnering fast-track approval for US laws. Current Senate rules usually require most laws to receive a majority of at least 60 votes, meaning any law being passed today would usually need the votes of all Democrats and 10 Republicans.
But the Congressional Budget Act of 1974 paves the way for a simple majority to pass certain types of legislation. Given the nature of the pandemic, the Biden administration passed the previous coronavirus package without the support of any Republicans as Democrats argued that most Americans were more concerned about getting stimulus relief than focusing on the process itself, with covid rippling across the country. That said, Democrats reportedly want Republicans to be more involved this time.
What the proposal means for your portfolio
It may be a little too early to speculate on the expected effect of the proposals, given they are yet to be announced.
But the proposals again bring inflation to the top of investors’ minds. Economists and market participants are already arguing over whether or not the previous coronavirus package is set to overheat the economy. Economist Larry Summers, who served as US treasury secretary under the Clinton administration and is hardly an ardent conservative, described the stimulus package is the “the least responsible macroeconomic package we’ve had in the last 40 years.”
So if the new $3trn package (or even part of it) makes much progress, the US bond market seems likely to come under further pressure, as expectations of higher inflation and a stronger economic rebound from the pandemic grow even stronger. Even if it is partly paid by taxes (which would offset the inflationary effect by taking money out of the economy), it’s unlikely that the entire bill could be covered that way.
That doesn’t mean the Federal Reserve will feel the need to act. The Fed has committed to keeping interest rates near zero until at least 2024, and to continue its current quantitative easing programme until maximum employment is achieved and inflation rises above 2% persistently and on average. But the central bank might need to act more aggressively if markets really start to believe that its benign view of inflation is wrong.
As for the effect on stocks, higher corporation taxes of up to 28% would dent corporate earnings by 9% in 2022, says David Kostin, chief US equity strategist at Goldman Sachs. That said, stronger growth, driven by the infrastructure spending, could partly offset this, reckons UBS’ head of equities Americas, David Lefkowitz.
But as Goldman Sachs points out, the “growth” stocks that have been driving the bull market since 2009 are more vulnerable to a rise in both corporate and taxes on foreign income compared to cyclical stocks. They are also more likely to struggle with inflation.
The companies set to benefit the most from Biden’s infrastructure plans will be industrials and material firms, says Bank of America – all cyclical stocks. Financial stocks may also benefit as rising bond yields improve the profitability of banks.
In all, if the infrastructure deal passes, the message to investors is more of the same: the “Great Rotation” from growth and tech towards cyclical, value stocks such as energy, materials, industrial and financials, will simply continue.
Saloni is a web writer for MoneyWeek focusing on personal finance and global financial markets. Her work has appeared in FTAdviser (part of the Financial Times), Business Insider and City A.M, among other publications. She holds a masters in international journalism from City, University of London.
Follow her on Twitter at @sardana_saloni
In the doghouse: hundreds of investment funds are underperforming - is it time to sell?
News The latest Spot The Dog research from Bestinvest reveals 151 funds are failing to beat their benchmark. We reveal the worst performers
By Marc Shoffman Published
Nationwide: House prices creep up for the first time in over a year
Nationwide’s latest house price index reveals property prices are finally rising. Will this pattern continue in 2024?
By Vaishali Varu Published
UK wages grow at a record pace
The latest UK wages data will add pressure on the BoE to push interest rates even higher.
By Nicole García Mérida Published
Trapped in a time of zombie government
It’s not just companies that are eking out an existence, says Max King. The state is in the twilight zone too.
By Max King Published
America is in deep denial over debt
The downgrade in America’s credit rating was much criticised by the US government, says Alex Rankine. But was it a long time coming?
By Alex Rankine Published
UK economy avoids stagnation with surprise growth
Gross domestic product increased by 0.2% in the second quarter and by 0.5% in June
By Pedro Gonçalves Published
Bank of England raises interest rates to 5.25%
The Bank has hiked rates from 5% to 5.25%, marking the 14th increase in a row. We explain what it means for savers and homeowners - and whether more rate rises are on the horizon
By Ruth Emery Published
UK wage growth hits a record high
Stubborn inflation fuels wage growth, hitting a 20-year record high. But unemployment jumps
By Vaishali Varu Published
UK inflation remains at 8.7% ‒ what it means for your money
Inflation was unmoved at 8.7% in the 12 months to May. What does this ‘sticky’ rate of inflation mean for your money?
By John Fitzsimons Published
VICE bankruptcy: how did it happen?
Was the VICE bankruptcy inevitable? We look into how the once multibillion-dollar came crashing down.
By Jane Lewis Published