What Are The Next Steps For US Fiscal Policy: A Goldman Q&A

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by Tyler Durden
Monday, Apr 12, 2021 - 06:00 PM

Two weeks ago, President Biden proposed to spend over $2 trillion over the next decade on an “American Jobs Plan”, a forthcoming “American Families Plan” looks likely to be nearly as large. Goldman expects Congress to pass most of this proposed spending later this year, including nearly all of the “hard infrastructure” spending that President Biden proposes, as well as most of the research, manufacturing, and “green” incentives. It also expects Congress to approve the social benefits the White House proposes but in a scaled-back form. Overall, Goldman's economists expect this would amount to around $3.3 trillion over 10 years (1.1% of GDP on average over that period).

The White House has proposed to offset the cost of most of the “Jobs Plan” with corporate tax increases. Personal tax hikes and capital gains taxes would cover most of the cost of the second package, although in light of the latest woeful budget deficit, where YTD taxes cover only half the government spending, this seems like an overly optimistic assumption.

In any case, Goldman expects Congress to raise taxes but not as much as Biden proposes: this would include a corporate tax rate in the 25% range and some of the international changes the Treasury proposes. Individual tax rates look likely to rise, but capital gains taxes will stop short of the near-doubling the White House is proposing. Goldman also expects little net increase inindividual taxes, as new revenue is likely to be used for new tax benefits.

New spending and tax increases look likely to phase in gradually and the combination looks likely to increase the deficit over the next few years. However,even if Congress passes only part of the President’s proposed tax increases, the package will leave the deficit roughly unchanged over the long run, as budget rules are likely to prevent a permanent expansion.

Over the next few weeks, we will learn more about the White House’s plans on individual taxes and benefit programs and by next month, the legislative strategy for passing these changes should become clear. For now, the most likely scenario is that Congress passes a single large bill in Q3,but alternative scenarios are possible.

With that in mind, here is a handy self-Q&A by Goldman chief political strategist, Alec Phillips, laying out the Next Steps for US Fiscal Policy.

Q.What has the White House proposed?

Altogether, the “American Jobs Plan” amounts to around $2.6 trillion in new spending and tax incentives. The White House has formally proposed the items in the left column of Exhibit 1 in its “American Jobs Plan” (AJP). What we label as “heavy infrastructure” consists of physical infrastructure spending that we expect most lawmakers would view as infrastructure in the traditional sense. Senate Republicans might be willing to support legislation that is largely confined to these areas, if it is not financed with personal or corporate income tax increases.

The second category in the left column of Exhibit 1 consists of the other proposals in AJP. Some have the potential to win bipartisan support if considered separately. For example, we would expect that there might be Republican support for some of the manufacturing, supply chain, and R&D incentives in the proposal, though probably not at the level the White House has suggested. By contrast, we would expect that most of the climate-focused proposals, housing and school construction, and the proposed Medicaid expansion could pass only via the reconciliation process with Democratic votes.

Q.What will the White House propose later this month?

The White House looks likely to propose to establish new benefit programs and to extend the low- and middle-income tax credits Congress enacted earlier this year. The upper right column consists of a third set of proposals that President Biden made during the campaign and that the White House might include in its next proposal, called the “American Families Plan” (AFP). We expect the White House to release details of this plan in the next few weeks. That plan is likely propose extending tax credits that Congress recently passed as part of the “American Rescue Plan” on a temporary basis that we believe lawmakers will press to extend or make permanent (bottom right category of Exhibit 1). Making these permanent would cost more than $2 trillion over the next 10 years. In light of this cost, the White House might extend the child tax credit only to 2025, for example, when a number of other tax polices currently in place are also due to sunset.

Q.How does the White House propose to address the budgetary impact of its proposals?

Tax increases would offset most of the proposed spending. The White House has also put forth a number of tax increases to offset the majority of the budgetary impact of the new spending it proposes. The left column of Exhibit 2 summarizes the recent corporate tax proposals from the Treasury, which it has labeled the “Made in America Tax Plan”. Estimates from the Treasury and other sources suggest the proposal would raise slightly less than $2 trillion over the next ten years. However, the overall increase in corporate tax receipts would likely be much smaller, as these tax increases would likely go to finance a number of new tax incentives the AJP would provide.

We also expect the White House to propose additional budgetary savings through increased tax rates and other policy changes directly affecting higher-income individuals. The right column of Exhibit 2 summarizes President Biden’s main campaign proposals in this area, along with some other items that we expect might be included.

Q: When would the spending occur?

Benefit programs would likely reach their full spending rate within a year of enactment, but infrastructure spending might take a few years to peak. Exhibit 3 shows our estimates of the annual rate of spending under the AJP as proposed and under our assumption of what the AFP might include. To estimate the pace of spending, we use the spending pattern from estimates of other similar proposals from the Biden campaign, prior congressional proposals, or previous budget proposals from the Obama Administration, adjusted to reflect the known details of the Biden Administration’s plans.

The cost of extending the recently enacted ARP policies would be spread roughly evenly over the next decade, we believe. Other parts of the AFP, like child care and education proposals, would build over the course of the next ten years. Infrastructure spending would ramp up over a few years, peak around 2025-2026, and then begin to fade.

Q: How much of this is likely to pass?

We expect Congress to pass proposals totaling $3.3 trillion over the next ten years. Specifically, as shown in Exhibit 4, we expect Congress to enact nearly all of the physical infrastructure, most of the manufacturing, R&D, and green incentives, and around half of the rest of the “Jobs Plan”. We expect that Congress will also enact the majority of the forthcoming “Families Plan” proposal, including extending nearly all of the expiring tax credits that Congress recently enacted, at least to 2025, and most of the other benefit expansions that President Biden looks likely to propose in that plan.

With regard to taxes, we expect that congressional Democrats will raise the corporate tax rate to 25%, rather than the 28% President Biden proposes, and that the revenue raised via international tax proposals (e.g., GILTI) will be cut roughly in half.

With regard to individual taxes, we expect that the top marginal rate will rise to 39.6% and that long-term capital gains and qualified dividends will be taxed at around 28%, rather than the 39.6% the White House has proposed. While we expect Congress to restore the income-related limitation on itemized deductions that the 2017 tax reform law eliminated through 2025, we think it is unlikely that Congress will go further and limit deductions for high income earners to 28% (rather than their marginal tax rate).

Despite the fact that the Biden Administration has not proposed to fully restore the deduction for state and local taxes, we expect Congress to at least expand it. A full restoration is possible but, at a cost of around $80bn per year, it would cost $400bn to fully reinstate it for 2021 through 2025 (after 2025 it reverts to the pre-2017 policy even if Congress does nothing). A full reinstatement is possible, but Congress seems more likely to raise the cap from the current $10k per household. At a minimum, we would expect the deduction to at least double for married filers, to $20k (the current $10k limitation does not distinguish between single and married filers). More likely, the cap would expand a bit further, perhaps to something like a limitation of $50k per household. For taxpayers in jurisdictions with high state and local taxes, this would work out to something similar to a full deduction for joint filers up to $400k, the threshold the Biden Administration has suggested for a number of other policies. However, this would cost only a fraction of the cost of fully restoring the deduction.

Q: When would the tax increases take effect?

Taxes look likely to rise in 2022, but the chance of a gradual phase-in is greater than the chance of a retroactive hike. White House and congressional Democrats have indicated they would support many of the proposed tax increases on policy grounds even if they were not seeking to raise revenue. That said, Democrats have two more practical motivations to raise taxes. Neither suggest there is much need to raise taxes quickly. First, winning the support of centrist Democrats in the House and Senate might require Democratic leaders to lower the cost of the legislation, and tax increases would be one way to accomplish this. However, there is likely a limit to how far some centrists will be willing to hike taxes and some might prefer to postpone some tax increases until after the midterm elections.

The second reason to raise taxes is the reconciliation process. Congressional rules prohibit reconciliation bills (see below) from increasing the deficit after 10 years. To make any of the tax credits or benefit expansions permanent, congressional Democrats would need to fully offset them with new taxes (or other savings). This could lead congressional Democrats to phase out some costly provisions several years from now, while postponing some of the more controversial tax increases for several years. Doing so would allow them to enact their preferred policies in the short run, while still abiding by budget reconciliation rules. This is the strategy Republicans used in the TCJA in 2017, which cut individual taxes through 2025 and tightens several corporate tax policies over the next several years.

We expect that individual tax increases would take effect for 2022, as the 2017 individual tax cuts were temporary and congressional Democrats will want to raise as much revenue as possible before they expire in 2025. The tax increase on long-term capital gains and qualified dividends also seems likely to take effect no later than Jan. 1, 2022, though this is an area where Congress might contemplate a mid-2021 tax change in order to prevent taxpayers from realizing gains at the lower rate. Corporate tax changes are also likely to take effect for 2022, but might phase in over more than one year, particularly since it could take several months for the Treasury to implement complex international tax changes.

Q: How and when might these proposals pass?

The reconciliation process is likely to come into play. We also see three ways that these policies could pass, as summarized in Exhibit 5. The most likely scenario is that Democrats pass a single bill through the reconciliation process that includes most of the proposals in President Biden’s “Jobs” and “Families” plans. The benefit of this approach is that the legislation would need no Republican support as long as every Democrat in the Senate and nearly every Democrat in the House is willing to support it. The risk in this approach is that some centrist Democrats might balk at passing such a large bill through the reconciliation process, which could delay or potentially imperil passage.

A plausible though somewhat less likely alternative is that Democratic leaders could break out some of the items the White House proposes and pass them separately, under regular order with bipartisan support. We think there is a reasonable likelihood that a sufficient number of Senate Republicans could support an infrastructure package costing several hundred billion dollars over 10 years, as long as it is not financed with income tax increases (in this scenario, we would expect a combination of user fees and deficit financing). There might also be Republican support for legislation that Senate Democrats are developing ostensibly to increase US competitiveness with China. This package looks likely to overlap with the R&D and manufacturing proposals in the President’s “Jobs” plan. At the moment, neither of these looks more than 50% likely to pass, but both appear possible.

In this scenario, we would expect congressional Democrats to plan to pass the remaining elements of the President’s plan via the reconciliation process with only Democratic support, and financed through corporate and individual income tax increases. A risk in this strategy would be that passage of the first two standalone proposals could reduce support for passing the remaining items on the agenda through the reconciliation process. This is the only scenario we can envision in which Congress does not enact a substantial tax increase this year.

A third approach would be to pass the “Jobs” and “Families” plans separately, using the reconciliation process for each. The odds of this have increased slightly, as a result of the Senate parliamentarian’s reported ruling that Congress can amend the budget resolution it already passed in February to provide procedural protections for a second reconciliation bill. This decision is not surprising but the fact that Senate Majority Leader Schumer sought the ruling suggests that he is considering this strategy. However, we think this is less likely than a single-bill approach. Passing a large fiscal package in Q3 that includes tax increases would likely reduce political momentum for a second package that also raises taxes, particularly among centrist Democrats whose support would be essential. If congressional Democrats believe that the odds of a second package are low, they are likely to press to include essential items in the first package, reducing the need for a second bill. The upshot is that while congressional leaders appear to be considering two large reconciliation bills, we expect that one even larger bill is more likely.