“Big and beautiful” or not?

Right on cue, political jabs about the tax and budget bill recently passed in the U.S. House of Representatives – formally called the “One Big Beautiful Bill Act” – are heating up, and the legislation is increasingly catching investors’ attention.

The political theater might be amusing to us if the country’s federal legislators were held in higher standing – the collective rating of the House and Senate is currently at only 26 percent, according to Gallup – and if their track record on managing spending and the country’s debt load was better.

Tax relief usually brings relief to the stock market

We think the stock market generally favours the tax and stimulus provisions in the budget bill – political rhetoric aside.

• The House version of the bill extends the low tax rates for individuals that became effective in 2018 during President Donald Trump’s first term;
• includes new tax exemptions on gratuities and overtime pay;
• provides an extra $4,000 tax deduction for filers age 65 and older;
• includes a new $1,000 cash payment for newborns in an investment account and additional investment incentives in such accounts, and higher tax credits for families with children;
• and incorporates generous business incentives, including accelerated depreciation of capital investments.

In fact, we can’t remember a time when the stock market hasn’t embraced low tax rates, tax exemptions and direct cash payments, and business incentives – regardless of fiscal implications.

The stock market’s general logic is that the more money in individuals’ pockets and businesses’ accounts, the more spending on goods and services – which can benefit some S&P 500 companies and others listed on stock exchanges by boosting profit growth, at least somewhat.

A leery bond market

However, the bond market seems to see this differently. It’s starting to act more like a responsible adult or grandparent, in our view.

Treasury market investors – especially large institutional investors in the U.S. and abroad – are taking a more circumspect look at the deficit and debt projections associated with the legislation.

The nonpartisan Congressional Budget Office (CBO) – the official scorekeeper of the costs associated with such legislation – projects the bill will increase annual federal deficits over the next 10 years by $2.4 trillion cumulatively. In other words, tack on that amount to the country’s current $37 trillion in federal debt.

The White House and many Republicans argue it won’t end up nearly this bad and future deficits could decline, whereas Democrats say deficits will be far worse. Regardless, it’s anyone’s guess as far as we’re concerned.

We think fuzzy math has dominated Washington for decades. Previous budget bills passed under the leadership of each party and scored by the CBO, along with loads of additional spending on emergencies and for other purposes, have pushed federal government finances deep into the red.

Importantly, we think the bond market is starting to show signs of being less tolerant of ultra-high deficits.

Stumbling blocks in the Senate

We anticipate difficult negotiations between Senate and House Republicans before the “One Big Beautiful Bill Act” can arrive on the president’s desk for his signature.

There are a few key provisions currently in dispute, including one affecting foreign investors.

Overall spending levels and the need for deficit reduction: Some Republican senators, especially those with libertarian leanings (Senators Rand Paul, Mike Lee, and Ron Johnson), strongly disagree with the high spending levels and fiscal deficits associated with the House bill.

SALT deduction: The House bill raises the cap on the state and local tax (SALT) deduction to $40,000, which benefits taxpayers in high-tax states. Many Republican senators in low-tax states strongly oppose this.

Medicaid spending: The House bill includes a work requirement for some Medicaid recipients. Some Republican senators oppose what they view as cuts to Medicaid benefits and are concerned about lower-income individuals potentially falling off the health care insurance rolls; Democrats agree with them.

Section 899: This controversial section of the House bill contains “retaliatory tax provisions” on select foreign governments, overseas companies, and foreign investors in certain U.S. securities. As written, the language is complex yet vague in some areas, and there are disagreements between tax specialists on which securities and which foreign investors would be impacted.

In practice, according to the Tax Foundation, a Washington, D.C.-based nonpartisan tax policy firm, Section 899 targets countries that have instituted a global minimum tax or have digital services or diverted profits taxes. It assesses that certain entities and individuals in Canada, the UK, many EU countries, and Australia could be affected if these taxes remain in place or these foreign governments are unable to negotiate a compromise with the U.S. government.

The Tax Foundation views Section 899 as being harmful to the U.S. economy due to its potential implications on foreign direct investment into the U.S. We also view it negatively for this reason. Furthermore, the legislative language currently includes a lot of gray areas and cedes wide discretion to the Treasury secretary to specify retaliatory taxes and other issues.

We would be surprised if the House’s Section 899 language stays intact after going through the Senate.

Financial industry lobbyists and foreign lobbyists are already trying to get the Section 899 House language either:

• modified to minimise the impact on foreign investors and companies;
• clarified to spell out the retaliatory taxes much more clearly and provide the Treasury secretary with less discretion;
• or stripped from the bill altogether.

Also, it’s possible there will be at least one procedural challenge in the Senate to remove Section 899.

It’s normal for the Senate to modify controversial provisions of House bills, especially when it’s being lobbied hard. We never underestimate industry lobbyists’ power and influence, and the financial lobby has been successful in the past in achieving at least some of its objectives.

Moving toward the finish line

Regardless of the merits and demerits of the “One Big Beautiful Bill,” we think House and Senate Republicans will be forced to ultimately craft compromise legislation out of political necessity – although the process could get very messy.

This is because if they fail to do so, a major tax increase would occur in 2026 on individuals, ahead of the midterm elections in November of next year. Therefore, we think Trump has every incentive to spend a lot of political capital to muscle through a final compromise version of the bill in both chambers.

This doesn’t, however, make us any less concerned about the very high federal annual deficit and cumulative debt.

Our forthcoming Global Insight 2025 Midyear Outlook, available in mid-June, will discuss how investors in U.S. stock and bond markets should perceive the risks associated with the runaway federal debt and high annual deficits. Stay tuned.

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