What’s on the horizon for the new proposed House reconciliation bill?

The House made significant progress with its reconciliation bill this week, and even though progress was delayed Friday, nonetheless the language allows us to assess its possible impact. In U.S. legislation, a reconciliation bill allows budget-related measures to pass in the Senate with a simple majority, bypassing the typical 60-vote threshold needed to overcome a filibuster. This process is crucial for advancing significant fiscal policies, such as tax cuts or adjustments to mandatory spending, when bipartisan support is limited. Reconciliation was the route used for the Tax Cuts and Jobs Act (TCJA) of 2017 during Trump’s first presidency. This week, most House committees have approved their portions of the reconciliation legislation, which include an extension of that bill.

Below, we recap the TCJA’s impact on the economy and markets, and what a new bill could potentially mean.

The TCJA of 2017 was a significant overhaul of the U.S. tax code, enacted under President Trump. It aimed to stimulate economic growth by reducing tax burdens on individuals and businesses. Before the TCJA, the U.S. tax system was characterized by relatively high corporate tax rates and a complex individual tax code. The corporate tax rate stood at 35%, one of the highest among developed countries, which many argued made the United States less competitive globally. The individual tax system had seven tax brackets, with a top rate of 39.6%. There were numerous deductions and credits, but the system was often criticized for its complexity and inefficiency.

The TCJA was a key component of Trump’s economic agenda, aimed at boosting economic growth, job creation and investment in the United States. The Republican-controlled Congress prioritized tax reform, seeing it as a way to deliver on campaign promises and stimulate the economy. The bill was introduced in November 2017 and passed through a budget reconciliation process. The TCJA was a landmark piece of legislation that significantly altered the U.S. tax landscape.

The draft budget resolution by the House and Senate now unlocks the process to extend that bill, with a target date of July 4. Here’s what that could mean:

However, extending these tax breaks is not a free lunch. When we think of the United States as a business, which has revenues and expenses, lowering the tax rates reduces the country’s “revenue” and, if expenses (Medicare, Social Security, defense spending, etc.) are not reduced, increases the deficit.

According to the Committee for a Responsible Federal Budget (CRFB), the developing House reconciliation bill is shaping up to add roughly $3.3 trillion to the debt through Fiscal Year (FY) 2034, and is setting the stage for more than $5.2 trillion of additional debt if policymakers ultimately extend temporary provisions. The CRFB estimates that by 2034, the drafted House reconciliation bill would:

• Increase debt by $3.3 trillion, or $5.2 trillion if made permanent
• Increase annual deficits to $2.9 trillion (6.9% of GDP), or $3.3 trillion (7.8% of GDP) if made permanent
• Increase yearly interest costs to $1.8 trillion (4.2% of GDP), or $1.9 trillion (4.4% of GDP) if made permanent
• Increase debt to 125% of GDP, or 129% of GDP if made permanent

Our recently launched Tax Policy Hub includes weekly Washington Watch updates to provide more information on this process and potential tax changes. For now, we think investors with the ability and desire to do so, should continue to make gifts up to their gift and GST tax exclusion amounts.  While the bill in negotiation would make permanent the $15MM, inflation-adjusted lifetime exclusion, the scheduled sunset in 2026 still applies unless Congress acts otherwise. We are monitoring the negotiation developments closely, and will share potential action items once any tax legislation is finalized. To be clear, the bill as drafted is not final, and will likely change between now and the July 4 target date to accommodate lawmaker pushbacks, but we believe this bill could pose some risks (and opportunities) for the economy and markets. We explore those below:

To the economy: The fiscal stimulus the proposed bill would provide could help partially offset some of the negative growth impacts from tariffs. We estimate a roughly -1% hit to GDP due to tariff announcements year-to-date (post–May 11 U.S.-China reductions). However, we believe the stimulative portion of the proposed bill (extension of tax cuts, new tax cuts, spending increases) could offset two-thirds of the negative tariff impact.

On financial markets: It’s likely this proposed bill will increase fiscal deficits, and as a result, put upward pressure on Treasury yields in the United States. We believe concerns about the deficit are likely to alter the risk-reward profile of investing in longer-dated U.S. Treasury securities or securities with a comparable duration. This creates uncertainty and higher yields (term premium) at the longer end of the Treasury curve.

With that backdrop in mind, we think the latest draft of the bill may create investment opportunities.

Within fixed income: We prefer the risk-reward offered at the belly (~5 years) of the curve and in. This part of the curve is relatively less affected by the trajectory of U.S. debt and macroeconomic uncertainty, and more affected by the Federal Reserve. We have confidence that the next move the Fed makes is a cut rather than a hike, and as a result, we have more conviction in the short end of the curve.

Moreover, for taxable investors in the United States, the draft does not modify the municipal tax exemption. The seasonal supply/demand dynamics have led to a substantial cheapening in municipal bonds from a valuation perspective. From a fundamental perspective, the muni market is of very high quality. Since 1970, the 10-year cumulative default rate for investment grade municipal bonds has been just 0.1% (versus 2.2% for IG corporates). If heightened deficit fears put upward pressure on yields, we think this is an opportunity for investors to leg into municipal bonds.

As for equities: Increasing the fiscal stimulus in the United States could be a tailwind for stocks. Financials remain one of our preferred sectoral implementations in the United States. Net interest margins and net interest income are set to inflect higher, while capital markets activity is also poised to meaningfully accelerate. Credit conditions remain benign, while the regulatory environment will likely ease. This backdrop is favorable for banks and capital markets companies, and becomes more attractive in a steeper yield curve environment.

Infrastructure investment: For investors looking to avoid rate volatility that can arise amid higher fiscal deficits, we think infrastructure can add resilience to portfolios. Infrastructure investments can offer diversification and resilience, providing essential services with high barriers to entry and long-term contracts that include inflation escalators.

For questions on how the proposed reconciliation bill could affect your portfolio, reach out to your J.P. Morgan team.