The extra spending will be positive for the U.S. economy, though financial markets may react negatively to tax increases. For investors, beneficiaries from the bill present opportunities.
- President Biden laid out the building blocks of an infrastructure package, which will likely range between $2-$3 trillion, partially funded by higher corporate and individual taxes.
- The impact of the package may not be immediately felt by the economy. It could provide another 0.2%-0.4% boost to GDP growth in 2022 compared to what we have in our macro outlook (assuming a $1 trillion traditional infrastructure package). Spending will take time to ramp up, so the GDP impact is likely to be greater from 2023 to 2025.
- We think the size and composition of the infrastructure bill is not fully priced in. We recommend adding to liquid and non-liquid infrastructure assets and reducing overweights to low tax-paying corporations that are likely to see higher taxes.
- While there are select beneficiaries, the package is broadly a headwind due to higher tax rates; we expect a net $4 hit to S&P 500 earnings-per-share in 2022. Domestically-focused sectors such as Energy, REITS, and Utilities should be least impacted, while Technology and Communication Services could be hit hardest.
President Biden laid out the building blocks of a new fiscal package on infrastructure last week. There are still a lot of unknowns, but our base case is that a spending package gets signed into law. While this package is likely to be net positive for the economy, for financial markets the skew is more negative due to the proposed tax rate increases and offsets. In today’s Top Market Takeaways, we outline expectations for spending, how the bill might be paid for, what it means for the economy, and how to invest around the package.
Where will the spending go?
It is a top policy priority of the Biden Administration to address underinvestment in infrastructure Federal spending on roads, highways, and transportation as a share of potential GDP has more than halved since the 1950s, and the average age of the capital stock for transportation infrastructure has steadily increased from five years to nearly 40 years. Federal infrastructure spending is fairly low as a share of GDP for many countries (China, Australia, South Korea excluded, spending 5.6%, 1.7%, and 1.6% of GDP respectively), but the U.S. is a laggard, spending just 0.3% of GDP on infrastructure annually. Additionally, infrastructure for the digital economy is severely lacking. Tens of millions of Americans, particularly in rural areas and schools, do not have access to or cannot afford high quality internet service.
Washington analysts have high conviction that the bill will have a headline price tag of around $2-$3 trillion. The American Jobs Plan, unveiled last week, is the opening salvo of the negotiation. The $2.25 trillion proposal will be spent over eight years and features some green spending, but the largest share is for physical infrastructure such as roads and bridges. This investment is forecast at $621 billion, more than double the annual U.S. spend of late. Further, Biden plans to unveil the second pillar of the agenda, “human infrastructure”, in the coming weeks – including extending paid leave, child and healthcare tax credits provided in the COVID relief bill, national childcare, a universal preschool program, and free community college. Estimates suggest this pillar of Biden’s agenda could cost above $1 trillion and will be financed with individual tax rate increases.
How might it be paid for?
Tax rates are going up. Expectations from those close to Washington are that at least half of the bill will be paid for with higher tax rates. There is broad consensus that three tax rate increases are likely:
1) Raise the top marginal income tax rate for the wealthiest Americans. The highest individual tax bracket was already scheduled to reset to 39.6% from 37% in 2025 when tax rate cuts enacted in 2017 expire, so this bill would just accelerate that timeline to 2022. This will likely be highlighted when the “human infrastructure” proposals are announced.
2) Raise corporate income tax rates. While most are not expecting a full reversal of the 2017 corporate tax cuts, the proposed move towards a 28% statutory corporate tax rate and a 15% Alternative Minimum Tax (AMT) for large companies could raise nearly $1tr over ten years. Keep in mind that before the 2017 cuts, the corporate income tax rate was 35%, so from Congress’ perspective, a 25% or even 28% corporate tax rate is still substantially lower than it was just a few years ago.
3) Close tax loopholes. Democrats in Congress believe U.S. companies with low foreign tax rates are not paying their fair share. As it stands today, U.S. multinationals are paying 10.5% on their foreign earnings assumed to be coming from intangible assets (the Global Intangible Low-Taxed Income, or “GILTI”), and President Biden has proposed increasing that to 21%. There has been little opposition from Congress on this to date, although companies will certainly push back.
What does it mean for the U.S. economy?
We anticipate no impact this year, and a modest GDP boost for 2022. A $2 trillion-plus package is at least double what we have in our macro assumptions and would provide another 0.2%-0.4% boost to GDP growth in 2022, versus our estimate of a $1 trillion traditional infrastructure package. The spending is likely to be “middle loaded” - as it takes time to ramp up spending - so the GDP impact would be greater in 2023 and 2024. Furthermore, $300bn of the bill is just to keep the status quo infrastructure maintenance spend going. Importantly, tax rate increases are a partial offset and represent a headwind to higher growth (less disposable income = less spending).
What about inflation? Due to the short supply of construction workers last cycle, there are concerns about the bill pushing up near-term inflation – but we are not worried. Given the lead-up time to get “shovels in the ground,” the bill should have limited impact on near-term wage inflation and there is time to get workers ready and qualified to contribute1. Additionally, non-residential construction and heavy and civil engineering employment is down 6-7% from their pre-COVID levels.
For the Fed, the package will likely change nothing in the next year or two. And in fact, they are likely excited: recall that they are actively pushing inflation higher, and this bill helps. For longer dated Treasury yields, the bill should serve to steepen the curve a bit more.
What does it mean for investors?
For investors, there are multiple ways to invest around the package. From an equity perspective, industrial, material and transportation companies are apparently in a good position as beneficiaries of additional spending on traditional infrastructure. Companies involved in digital infrastructure, such as cable/tower makers, semiconductor manufacturers, software platform providers, etc., also emerge as an interesting theme that benefits from both this package and a longer-term-secular-trend perspective. In addition, green infrastructure will be a key beneficiary of the bill. We were believers in clean energy names before the recent sell-off in this sector, and now the entry point looks more attractive. Certain Asian producers of related core parts - such as the polysilicon used in solar modules and semiconductor chips used in electric vehicles - could also benefit from this strengthened demand outlook in the U.S. in the long term. We also like private assets in the infrastructure space, which enjoy a substantial yield pickup compared to public equities. We would also recommend reducing overweights to currently low-tax-paying corporations, i.e. certain multinationals in technology and communication service sectors, as their earnings are likely more sensitive to higher corporate taxes.
1 Trillion Dollar Infrastructure Proposals Could Create Millions of Jobs, Georgetown University Center on Education and the Workforce, 2017 (link)
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