Looking Beyond Budget Bluster

Editors’ Note: MarketMinder is politically agnostic. We favor no party nor any politician and assess developments for their potential economic and market impact only.

After many days of rumors, previews and waiting, the Biden administration has at last released its proposed budget for fiscal year 2024. As most anticipated, it is a hodge-podge of increased spending and higher taxes that reheats some prior proposals and turns others up a notch. Much of the coverage understandably focused on the tax implications, which would raise levies on high earners and corporations while extending the Trump administration’s tax cuts for folks making less than $400,000 annually. In other words, investors saw some things to fear and others to cheer. If recent history is a guide, we will see numerous think pieces on why the proposals are bad, good or neutral for the US economy and markets. Steel yourself now to remember it is all politicking, and deep gridlock likely means neither party’s budget passes as originally written—fine for stocks.

Whenever we dive into politics, we suggest readers first put their political leanings and biases to the side. Once you filter things through your view of personalities and partisan preferences, you introduce blind spots and detach yourself from how markets work—in our view, a recipe for error. Stocks don’t get hung up on politicians’ words, intentions and personalities, and they are party blind. They don’t view anyone or any caucus as inherently good, bad or neutral for future returns or the US economy. We think stocks’ focus is always on a simple question: What are the proposed policies, what is their potential impact (both immediate and downstream), and what is the likelihood they take effect as initially outlined? Neither party has a monopoly on—or innate tendency toward—beneficial or deleterious policies on this front, in our view.

So let us set aside any and all chatter about the president, the cabinet, individual congresspeople and the two main parties—and let us instead look at the tax measures proposed today. Like all tax changes, we think it is fair to say they would create winners and losers. Extending the 2017 tax cuts for those making under $400,000 annually—which are set to sunset in 2025—would benefit those households, especially if the standard deduction holds steady. Raising the top individual rate for incomes over $400,000 from 37% to 39.6% would return that rate to its pre-2017 level while reducing the income threshold a bit. Not great for the relevant individuals, but that rate didn’t prevent growth before 2017’s reforms. Arguably more significant: the proposed 25% minimum tax rate on wealthy households’ income and unrealized capital gains, as well as the proposal to hike the capital gains tax rate from 20% to 39.6% for people making $1 million or more annually. Ditto the proposal to raise the corporate tax rate from 21% to 28%, quadruple the current 1% tax on stock buybacks, double the tax rate on corporations’ overseas income from 10.5% to 21% and end some tax breaks for oil and gas companies. All would shift incentives, although the extent to which that would alter investment isn’t clear. For instance, the 1% tax hasn’t deterred buybacks thus far, but a 4% levy might change the calculus some.

Should any of these measures become likely to pass, there will be time to crunch the numbers and assess the probable impact. But we are skeptical it will get to that point. As most coverage has pointed out, the likelihood this budget passes Congress rounds to zero. Prior versions of this wish list couldn’t pass Congress before midterms, when the Democrats had a tiny majority in both houses. Moderate senators like Kyrsten Sinema and Joe Manchin blocked the tax on high earners’ unrealized capital gains when the Biden administration proposed it with a 20% rate. It seems unrealistic to think an identical tax with a higher rate would suddenly become palatable to them, never mind that a Republican House would go for it. Or the vast majority of the other tax increases on offer here. This is one side’s starting position for summertime budget and debt ceiling negotiations. Soon the other side will release its starting position, and then the tough business of horse trading will begin.

So why bother releasing a budget with little chance of passage? We suspect the administration’s main purpose here is to stake out campaign territory ahead of 2024. President Joe Biden hasn’t officially declared he is running for re-election yet, but plenty of people close to him have indicated it is only a matter of time. Yet there is also significant rumbling about potential primary challenges. This budget proposal seems to us like a declaration of intent to potential rivals, making it hard for them to outflank him on fiscal policy.

In our experience, stocks are pretty good at seeing through politicking like this. It might not be apparent right now, given the coincidence of Biden’s announcement and another big down day for stocks. But stocks’ day job is pricing in probabilities for the next 3 – 30 months, and that includes the probability of big fiscal policy changes. The simple reality of a split Congress renders that probability very, very low. Both parties will likely have to scrap contentious proposals and sand down the ones where they are closer to having common ground. It wouldn’t surprise us if the result were some continuing resolution that no one is happy with—no one except stocks, which will have already learned to live with the status quo and will probably be relieved that they won’t have to contend with big changes.

This is why gridlock is so beneficial for stocks. Markets dislike even the potential for big change, as it forces businesses to reckon with the probability that by the time an investment today starts paying off, the tax and regulatory landscape will be different in ways they can’t predict. It doesn’t matter if proposals at any time are a net benefit or negative—all of which is a matter of opinion anyway. The simple prospect of change can discourage investment and risk taking. Gridlock eases this, giving businesses more confidence that the rules won’t change. With this gridlock in place through 2024 at least, politicians should be unable to throw major roadblocks in stocks’ way, making budget chatter a brick in the wall of worry for a new bull market to climb.