Last December, U.S. Congressional leaders surprised the markets with a massive agreement on year-end spending and tax breaks which helped lawmakers avoid yet another government shutdown, at least until September 2016. This deal was the broadest tax and spending deal since the January 2013 “fiscal cliff” agreement, which garnered a ton of media hype but ended with a predictable yawn. The most recent deal, which was combined with a $1.1 trillion spending package for 2016, is dominated by business tax breaks including more than $250 billion worth of tax breaks for individuals.
Tax breaks effectively cost the government money, and the 2016 federal budget deficit is expected to rise by $105 billion to $544 billion in 2016 ($130 billion more than the budget office had projected in August 2015).
The economic upside to tax breaks and more spending, in this case, outweighs the detriments of a larger deficit, in our view. A modest increased expenditure on the part of the government can flow through to more government jobs and stoke demand (since the government is essentially a huge customer to many corporations large and small). Higher government spending coupled with tax breaks increases the deficit, but only with the intention to improve demand on both sides.
Taken together, the shift in U.S. fiscal policy could add 0.8% to GDP growth over the next year.
On the tax front, credits being permanently extended are:
On the spending front, the government allocated $4.1 trillion in total federal spending for the fiscal year 2016, an increase of more than 5% over the total 2015 spending level. Out of the total proposed federal spending, mandatory spending nearly accounts for 65% (an increase of 5% from 2015) of the total spending whereas discretionary spending and interest on debt accounted for 28% (an increase of 2% and 7% from 2015, respectively). In mandatory spending, it was Social Security and Medicare that accounted for the lion’s share of the spending whereas military spending accounted for more than 50% of the total discretionary spending. The total proposed federal spending, as a share of U.S. GDP, is expected to be around 21.3% in 2016 whereas revenue, as a share of the GDP, is expected to be around 18.7%.
Bottom Line for Investors
The U.S. economy’s output during this expansionary cycle has been below its long-term average and, as we enter the late stages of the cycle, growth rates are likely to remain subdued by historical terms. An increase in fiscal expenditures can help boost aggregate demand and real GDP growth, providing a cushion where it’s needed today. It certainly won’t hurt.
Disclosure