President Joe Biden is set to propose a massive increase in infrastructure spending in Pittsburgh, Pa., on Wednesday, along with major tax hikes on corporations to offset their cost. Ahead of the official unveiling of a $2.25-trillion infrastructure plan, the S&P 500 rose to a new all-time high. But will the enthusiasm last as all the details of Biden’s infrastructure plan become clear?
The Biden infrastructure plan, which would take effect in October, at the start of the next fiscal year, promises to keep the U.S. economy humming through 2022. It includes $620 billion in spending on transportation, including roads, bridges, public transit and electric-vehicle incentives. It would spend another $650 billion on non-transit building efforts, including affordable housing, broadband, the electric grid and public schools.
Biden wants to spend $500 billion on growing the domestic manufacturing sector, with a focus on the chip industry, green manufacturing and R&D. The White House plan also includes $400 billion toward the in-home care sector, including pay for caregivers.
S&P 500 Reacts To Biden Infrastructure Plan
As more details emerged about the Biden infrastructure plan, the initial response on Wall Street looks favorable. As the U.S. economy recovers and corporate earnings surge this year and next, aided by government spending, most Wall Street strategists see stocks rising. That’s despite the headwind from tax hikes and rising interest rates.
In Wednesday afternoon stock market action, the S&P 500 rose 0.4%, hitting a record high intraday and closing in on the 4000 level. The Nasdaq composite, which has underperformed the S&P 500 since mid-February, rallied 1.5%, though closing off session highs. That makes up some lost ground, with Tesla stock and AMAT helping. The Dow Jones dipped 0.4%, still just below all-time bests.
Yet it’s possible that investment firms have been too sanguine about the scale of tax hikes that Democrats may pass.
Biden Tax Hikes
Biden’s unveiling of his infrastructure plan could begin to change those calculations. Biden, as he did in his campaign, is calling for a hike in the corporate tax rate to 28% from 21%. That would raise $730 billion, according to the Tax Policy Center. The Street also expects him to propose hiking the tax rate paid by foreign subsidiaries to 21%, raising $440 billion.
Yet the infrastructure spending is just the first part of a wider tax-and-spending package. That proposal will be further detailed in coming weeks and could total more than $4 trillion. Beyond infrastructure, Biden may seek permanent extensions of the child, earned income, child care and ObamaCare premium tax credit expansions approved with the stimulus, adding $2 trillion to the package.
Biden campaigned for universal pre-K, tuition-free community college, and federal paid leave. To the extent those priorities are included, the cost of the Democratic package could reach $5 trillion or more.
Axios has reported that the White House strongly favors two additional tax hikes to help pay for the cost of the next set of social-minded proposals that will be packaged with infrastructure.
Top Tax Rate Changes
The top individual income tax rate would rise to 39.6% for households earning more than $400,000, raising $110 billion.
The tax rate on long-term capital gains would jump from 20% to the regular income-tax rate of 39.6% for $1-million-earners, raising $370 billion.
While Biden’s plan may largely reflect his campaign proposals, Wall Street has been betting that proposed tax hikes would have to be sliced and diced to win support from moderate Democrats. That remains a possibility, but not one investors should bank on. Democrats already managed to pass a much bigger stimulus than big Wall Street firms expected.
The $1.9-trillion stimulus was a relatively easy lift. It didn’t require raising taxes. Yet a host of political, economic and fiscal forces may be pushing Democrats toward a more far-reaching reordering of government priorities than Wall Street has discounted.
Why Democrats May Rally Around Tax Hikes
Biden’s own words suggest a deep commitment to redistributive policies. “The decisions we make in the next few weeks and months are going to determine whether we thrive in a way that benefits all Americans or that we stay stuck in a place where those at the top do great, while economic growth for almost everyone else is just a spectator sport and where American prospects are dim.”
That excerpt from Biden’s speech on Jan. 14, which unveiled his $1.9-trillion stimulus, was less about recovering from the pandemic than healing chronic economic inequality. In Biden’s view, and likely that of most Democrats, the clearest political risk is not spending enough.
As vice president, Biden saw the GOP win back the House in 2010 amid a tepid recovery. Then he sweated through the 2011 debt-ceiling crisis and wrestled over the 2013 fiscal cliff. Investment at all levels of government took a hit, cutting nearly a half-point from GDP growth per year and sandbagging the recovery.
A big Biden infrastructure program would serve as an insurance policy, helping Americans whose jobs were permanently disrupted by Covid get back to work. That could keep Republicans from seizing back the mantle of economic populism in 2022 and 2024, as Donald Trump did in 2016.
S&P 500 Boom May Boost Tax Hike Support
Investment analysts figured tax hikes would be hard to pass as the economy faced a steep climb back from Covid. But many expect rapid vaccination progress and massive stimulus to produce a rapid economic rebound. Now, with the 10-year Treasury yield already rebounding much faster than expected, the Biden administration reportedly sees tax hikes as helping to limit interest-rate risk.
Still, the two-track Covid recovery, which has taken a toll on low-income workers while producing investment windfalls, may have softened reflexive opposition to tax hikes among centrist Democrats.
Both the unsustainable budget trajectory and Biden’s fragile governing majority suggest that the Democrats see this as a now-or-possibly-never moment to achieve their policy priorities.
Somewhat ironically, the loudest opposition within the Democratic party to high-income tax hikes now is coming from high-tax states like New York and New Jersey. Three House Democrats, not quite enough to give them veto power, say they won’t back Biden’s infrastructure and tax plan unless it reverses a $10,000 cap on the state and local taxes (SALT) deduction that was passed in 2017. Otherwise, they fear, high-income taxpayers will have greater incentive to leave their states.
Senate Majority Leader Chuck Schumer, D-N.Y., said Wednesday that he will push hard for restoring SALT deductions.
What Biden Tax Hikes Mean For S&P 500
It’s too soon to say how all this will shake out and how the S&P 500 will react. Yet after their recent success, it’s a good bet that Democrats will find a way to capitalize on their last, best chance to rewrite rules for the economy. If so, spending cuts, including drug price curbs from allowing Medicare to negotiate prices, will likely be part of the mix.
Ed Yardeni, chief investment strategist at Yardeni Research, wrote this week that Biden’s corporate tax hike “would reduce S&P 500 earnings per share by $15, to $200 in 2022.”
That 7% haircut is likely more than Wall Street has been pricing in. UBS equity strategist Keith Parker wrote on March 9 that he anticipates a 3.6% hit to EPS from Biden’s tax plan.
Parker wrote that hiking the tax rate on long-term capital gains from 20% to 39.6% could slice 1.5 points off the S&P 500 P/E multiple, potentially another 7% hit. UBS expects that not quite half that tax hike will become law.
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