Back in the day when Russell Long of Louisiana was chair of the Senate Ways and Means Committee, he used to tell a ditty to his colleagues: “Don’t tax you, don’t tax me, go tax that fella yonder under the tree.” Long was in effect telling the other senators that the easiest taxes to pass are those that affect the fewest constituents. In this spirit, communities have escalated hotel/motel taxes on guests, and some communities have a higher property tax structure for those who do not live in the same state. Neither group can vote against those increasing the levies.
With the $1.5 trillion (give or take) Build Back Better Plan of the Biden administration, trying to find someone to pay gets trickier. Right now, there are two focuses: billionaire families, and corporations.
Press reports tell us there are about 800 domestic families with a net worth in excess of $1 billion. As currently devised, such families will need to pay a capital gains tax on unrealized gains of up to 23.8 percent, spread over some time frame. There are already questions raised as to the tax’s constitutionally. The Sixteenth Amendment of the Constitution permits the government to tax income and estates but is silent as to assets accumulated by living members.
The second tax proposed is to raise corporate taxes to 26.5 percent from the current level of 21 percent. Only corporations that have over $1 Billion in annual profits would be affected. About 200 companies in the US currently qualify. For companies that generate enough tax deductions and credits to pay no taxes at this level of profits, the 26 percent would be a minimum tax, with any disallowed deductions eligible for future years, should they then qualify.
What has not been discussed is the expiration of many of the tax cuts passed by Donald Trump in 2017. If left unchanged, personal taxes will all snap back to pre-2017 levels by 2026. Only the corporate tax rate was permanently reduced.
This reduction/restoration of tax rates and deductions came about because the Trump White House could not show enough revenue increase from the tax cuts to make them permanent. Politically it was a gamble to see if the tax cuts were so popular, they would be maintained by future politicians.
By portraying the needed tax increases as spread over such a small number of people and businesses, the idea is to shine a light on the fact that the 2017 tax cuts actually benefited a very small group of people and businesses at a cost to a far larger group of voters.
The form of the proposed tax structure is not finalized, nor are the final expenditures included in the bill. The progressive liberal wing of the Democratic Party is threatening to withhold support for the bill if their own goals are not met. If carried out, such an act would be devastating to not only the chances of the Democrats to maintain control legislatively in 2022 but would also display the lack of influence of the President over his own party.
At present, there is a $1 Trillion infrastructure bill that has been passed by the Senate with Republican support. The Build Back Better bill of some unknown amount is being pushed by progressives. This second bill includes such items as free junior college tuition, enhanced Medicare benefits, family leave, higher minimum wage, child-care, and the like. This is the bill that divides the Democrats and has virtually no Republican support. Liberals refuse to consider the bills separately, knowing that if they did so, they would lack support for the latter. Thus, the current impasse.
President Biden is in the center of this. While most of the goals of the second Build Back Better bill were Biden political promises made while running for office, he did not commit to having them passed all at once. The political calculus is whether passing some version of the second bill will help the Democrats expand their representation in 2022, or will it contribute to them losing one or both congressional houses to the Republicans. If the latter occurs, expect no legislative progress until 2024.
The economic impact of the passage of either or both bills is diluted by the fact that the programs span five to ten years; thus while still in the billions, it must be looked at relative to a $24 Trillion economy. Items like junior college tuition payments and child-care would seem to be on target for enhancing the workforce and growing the economy. For some, the idea of the government providing for free what they had to pay for themselves is a bit difficult to accept. If in fact it encourages higher labor force participation and higher tax collections to boot, it may be worth it.
Economic activity continues apace. Many argue that the economy could do better if there were more workers/goods/supplies/etc., but this could be said of almost all advancing economies.
An example of economic distortion is the bromide that we are constrained by supply chains. In reality, more containers have been unloaded in domestic ports now than in 2019, the year before the pandemic. The problem is not so much the supply chain as the sheer volume of goods being imported. When Americans were locked down, those who still had incomes shifted from services (restaurants, vacations, air travel) to goods. Because so few goods are still made in this country, the shift triggered an avalanche of containers.
With the economic stimulus ending and forecasts of higher heating costs this winter, expect consumer spending to slow. Whether the economy slows with it may depend on the infrastructure bills now pending.
Just in time for Halloween, interest rate increases are back. While up fractionally domestically, signs of higher rates are popping up in other countries.
As for how high is higher: probably in the range of 2-2.5 percent on the ten-year US Government bond in the next 12 months. Not enough to derail the economy, but enough to call into question some investments being made at current levels.
Perhaps the most sensitive industry for interest rates is housing. While higher rates shrink the market for first-time homebuyers, it also reduces the pool of potential demand for those in appreciated properties thinking of downsizing. There is some regional arbitrage going on, with retirees leaving higher cost of living areas and buying homes in lower-cost areas. Higher interest rates may reduce the ability of such homeowners to freely move.
While currently not as scary as interest rates, inflation is growing stronger in the area where it is hardest to dislodge: wages. Higher wages, unless offset with productivity, are very difficult to deal with.
The endless discussions about what happened to the five million workers who seem to have evaporated since the pandemic started fail to confront the fact that they are not returning. Over three million consider themselves retired. Another two million have not returned for reasons ranging from lack of child care to the need to upgrade skills. These are issues the government can address if given the resources.
The Stock Market
Stocks seem to grind higher, aided by the sharp appreciation in the price of oil and gas.
With the backdrop of higher interest rates, it would seem some growth stocks may come under pressure due to valuations that previously did not need to compete with income alternatives.
Much of 2022 forecasting will depend on the chip shortage being resolved, as well as the lifting of limitations imposed by COVID. Recall that even when the US is vaccinated, much of the world is not. The ability to travel outside our borders may take longer than most people realize.
Warren M. Barnett, CFA
November 01, 2021
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