By Stuart Robertson, Portfolio Manager, and the TPG Investment Committee
For this quarterly commentary, we take a look at how today’s legislative environment might impact our financial markets. Politics is certainly an important influence on the markets; for the fourth quarter, the calendar on Capitol Hill is looking quite busy. As we write this, congressional leaders are negotiating two infrastructure bills, all while an approaching debt limit is threatening a government default. Nonetheless, we will attempt to provide an update of the current details of the bills, the state of negotiations, and discuss their potential impacts on the capital markets.
There are currently two separate infrastructure bills under negotiation. The first is a bill approved by the Senate with bipartisan support dubbed the “Infrastructure Investment and Jobs Act.” The total price tag was approved at $1.2 trillion, which contains $550 billion in new spending and additional funds allocated each year for highways and other projects. The bill was sent to the House of Representatives, and further adjustments are expected. The second package, titled “Building Back Better,” is a $3.5 trillion package mostly focused on human infrastructure and environmental spending. The smaller bill (as of 11/1/21) has yet to pass the House due to disagreement as to whether to pass both bills at the same time.
As you might imagine, there is intense discussion about how to pay for these bills, including the redistribution of unused COVID-19 relief funds, delaying a change in scheduled Medicare prescription drug rules, and the anticipated growth of GDP due to the infrastructure improvements (among others). The White House has also put forward several revenue-generating proposals. Their proposal calls for returning to a scaled tax on corporations as well as raising taxes on profits generated overseas. The proposal also would raise the top income tax rate for high-income individuals as well as raising the capital gains tax rate from 20% to 25% for these same individuals. These changes are projected to bring in an additional $1.1 trillion in revenue over the next ten years. And, perhaps not unexpectedly, Republicans have vowed to vote against any measure that includes tax increases.
Infrastructure bills are a challenge to assess for potential market impacts. Economists have long studied the potential impacts on economic output of investments in infrastructure. Some argue that increased government spending is a stimulus to the economy, but increased government spending can offset those effects by driving down or eliminating private spending, much like additional taxes can be a drag on businesses and individuals. We take comfort, though, that business leaders are generally quite adaptable and adjust their businesses to any new tax rate and rule changes. What we do know is that Apple will not stop designing new iPhones and Tesla will not stop producing electric vehicles. And as evidence of that, we see financial markets have performed well in both high-tax environments and low-tax environments. While there have been 13 corporate tax hikes since 1925, in all but three years the S&P 500 had a positive return for the following year. Congress has also increased the individual tax rate 14 times since 1925, and the S&P 500 increased the following year in all but two instances.
In case this wasn’t enough to roil the markets, the debt ceiling debate also has implications for the markets. While headlines may cause volatility in the short run, a “financial Armageddon” due to hitting the debt ceiling is unlikely. There have been five federal government shutdowns going back to 1990, and while a shutdown could cause some market jitters leading up to the event, rarely has it been a big negative for domestic equity markets.
Past Government Shutdowns Since 1990
A shutdown of government is one outcome of a failure to raise the debt ceiling, but a bigger question concerns default. A default is defined as failure to pay interest or principal due on outstanding debt. The debt ceiling, as written, does not prevent the US Treasury from refinancing maturing bonds, and today tax revenues vastly outweigh monthly interest payments. Additionally, the government can take extraordinary measures and suspend payments for things like the military, veterans’ benefits, and Social Security—each a draconian, but theoretically possible, a measure the Treasury could take to avoid default. Perhaps the only certainty is that as December approaches there will be more political mudslinging in the name of fiscal responsibility, and we expect the debt ceiling to be increased yet again. Markets have mostly shrugged off these worries in the past, and it is worth noting that no prior debt ceiling debate or government shutdown has caused a bear market or recession.
As the tongue-in-cheek expression goes, the US will always do the right thing after having exhausted all other options. While politics is virtually impossible to handicap, we take great comfort in the resiliency of the US economy. The onus is on businesses to adjust and adjust they shall. We understand the emotional impact the uncertainty in Washington has on us all, and we encourage you to reach out to us with any concerns or comments while we will continue to monitor the markets, your portfolio, and outcomes in Washington.
Sources: Whitehouse.gov, CBOE, Tax Foundation, PwC.
Advisory services offered through TPG Financial Advisors, LLC, an SEC-Registered Investment Advisor and a wholly owned subsidiary of The Partners Group, LTD.