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A Broad Bipartisan Infrastructure Deal Is Unlikely: Goldman

Courtesy of ZeroHedge View original post here.

In its latest Q&A assessment of the state of US fiscal policy, Goldman's economics team writes that while it "still looks broadly on track to meet our expectations, risks continue to tilt in the direction of a smaller spending boost and smaller tax hike than the roughly $3 trillion and $1.5 trillion over ten years that we expect." The bank then notes that "while a bipartisan deal on a broad infrastructure package cannot be ruled out, we continue to think the odds are against it, as there seems to be little agreement on financing it." Instead, Goldman expects Congress to pass a narrower infrastructure package focused mainly on transportation. If so, expect congressional Democrats to begin moving a broader fiscal package under the reconciliation process.

Reading recent headlines, one would be left with the impression of a wide range of spending outcomes – a boost of a few hundred billion to as much as $6 trillion over ten years – but the range of outcomes is not as wide as these figures imply. Most of the “traditional” infrastructure President Biden has proposed looks likely to pass, along with substantial R&D spending and renewal of personal tax credits that expire at year end. Together, these cost around 1% of GDP on an annual basis over the next few years. The remainder of the Biden agenda might boost spending by another1% of GDP, but Congress is expected to pare these proposals considerably.

Meanwhile, tax increases also still look likely, assuming that Democrats pass legislation using the reconciliation process. That's why Goldman has not changed its views much in this area, and still expects the corporate tax rate to settle around 25% along with more incremental versions of the international tax changes Biden has proposed. A capital gains rate increase is a close call, but a 28%capital gains rate is slightly more likely than the status quo.

Finally, the likely timing of fiscal action has also changed more noticeably, with likely enactment slipping from mid/late Q3 to Q4. This is due in large part to the continuation of bipartisan negotiations for longer than we had expected, which has led congressional Democratic leaders to delay the first procedural steps necessary to pass a reconciliation bill.

Below we republish the key aspects of Goldman's FIscal Policy Status Check Q&A:

Q: Will there be a bipartisan deal on a broad infrastructure bill?

A broad bipartisan infrastructure package still looks somewhat unlikely to us. Negotiations in the Senate have progressed and the odds have increased somewhat that a bipartisan bill covering many areas in President Biden’s program might pass. However, we still think there are obstacles to a broad deal and expect that most of the fiscal boost Congress approves this year will come through a reconciliation bill that passes with only Democratic support.

Unsurprisingly, there appears to be the most agreement on boosting traditional infrastructure spending. As shown in Exhibit 1, the current Senate bipartisan proposal comes close to matching the White House proposal in most areas of transportation infrastructure.

More controversial is how to address non-traditional infrastructure and how to finance the cost of any new spending. The latest bipartisan effort appears to have made some inroads on the former. It includes $65bn for broadband, which falls short of the roughly $100bn that the White House proposed but it would be the greatest federal investment to date and seems close enough to the Democratic target that this issue alone looks unlikely to hold up an agreement.

Other areas of non-traditional infrastructure in bipartisan discussions are much farther away from White House goals. Senate Republicans look unlikely to support substantial funding for electric vehicles or construction of affordable housing, for example. Clean energy is more of a gray area; Congress has previously approved, on a bipartisan basis, a number of different incentives for energy efficiency and renewable energy like wind, solar, and biofuels. However, the program President Biden proposes is on a much larger scale than existing subsidies and the latest bipartisan proposal includes only a fraction of what the White House is seeking in this area.

The greatest obstacle to prior political efforts at enacting an infrastructure program has been financing it. Here, there appears to have been much less progress (Exhibit 2). Each side has drawn lines they seem unlikely to cross: most Republicans oppose reversing any of the 2017 tax law or otherwise increasing income taxes—corporate or personal—to pay for the proposal. Most Democrats, including the White House, have ruled out increasing the user fees that finance most current infrastructure spending and appear uninterested in redirecting unspent COVID-relief funds.

The most likely area of overlapping support is closing the “tax gap” through greater enforcement of existing tax laws, but even this faces challenges. Congressional estimates of the potential revenue gain from closing the tax gap are much smaller than the Administration’s. The Congressional Budget Office estimated in 2020 that increasing IRS funding by $20 billion over ten years would produce $60bn in additional revenue, while a $40bn increase would raise $103bn (i.e., the first $20bn bump would raise $3 for each dollar spent, while the next $20bn bump in funding would raise only $2 for each dollar of extra spending). While it is possible that CBO might revise its estimate in light of arguments from the Administration, or that Republicans might agree to policies beyond an IRS funding increase, it seems unlikely that additional IRS funding would come anywhere close to covering the cost of an infrastructure proposal, at least according to the official estimate that Congress will rely on.

In our view, the only way that Congress will reach a bipartisan agreement on a broad infrastructure package is if lawmakers decide not to offset the new spending with savings elsewhere. So far, the White House and congressional Republicans have insisted that the bill should be paid for.

Q: Without a bipartisan deal, what happens with infrastructure legislation?

If a broad bipartisan deal fails, a narrow one is likely to pass. While a broad bipartisan agreement covering several aspects of the Biden proposal looks difficult to achieve, a narrower deal that primarily boosts transportation infrastructure looks likely to become law, for three reasons.

First, federal programs for most areas of traditional infrastructure—highways, public transit, rail, airports, waterways and drinking/ wastewater—already exist. The largest of them, which are collectively funded by the Highway Trust Fund (HTF), expire September 30. Traditionally, Congress reauthorizes these programs in five-year increments,sometimes after one or more short-term extensions until lawmakers reach agreement.The legislation to renew these programs cannot pass via the reconciliation process, soDemocrats will need Republican support for any short- or long-term extension. Theupshot is that it is nearly certain that some type of infrastructure legislation passes on abipartisan basis to avoid a lapse in the programs.

Second, some progressive Democrats seem likely to oppose an infrastructure bill that does not include substantial new policies related to climate and clean energy. Without their votes, greater support among congressional Republicans in the House and Senate would be necessary. To win greater support, the bill might need to narrow its scope further, to the point that it mainly extends existing infrastructure spending programs.

Third, financing a narrow infrastructure deal would not be nearly as difficult as financing the sort of bill currently under discussion. Existing transportation infrastructure programs already have dedicated revenue streams that fund most of their spending. Financing an incremental boost in spending on existing programs would be far easier than finding bipartisan agreement on several hundred billion dollars in new revenue or spending cuts.

Q: What difference does it make if Congress reaches a bipartisan deal on infrastructure?

A broad bipartisan infrastructure bill could reduce the odds that the rest of the Biden fiscal agenda becomes law. A broader bipartisan deal that overlaps with many areas of the Biden proposal could reduce centrist Democratic support for passing subsequent fiscal legislation through the reconciliation process. If this occurred, the spending boost over the next few years might be smaller than we have been expecting but corporate and capital gains taxes would also be less likely to increase.

By contrast, a narrower bipartisan deal limited to traditional infrastructure would still leave the door open for Democrats to pass a separate fiscal package through the reconciliation process that addresses much of the remainder of President Biden’s proposals. Relative to the scenario in which Congress passes a broad bipartisan infrastructure deal, passing a narrow transportation bill followed by a separate reconciliation bill would likely result in a greater overall increase in spending, partly offset by tax increases.

Q: What are the risks around spending levels under the different scenarios?

Congress seems very likely to approve spending and tax benefits equal to at least 1% of GDP over the next few years, but unlikely to go beyond 2% of GDP. Headlines regarding fiscal proposals over the last few weeks have run the gamut from a boost of only a few hundred billion at the low end (the Republican infrastructure proposal) to $6 trillion over ten years at the high end (the reported spending total Senate Democrats are considering).

However, these large figures overstate the range of realistic scenarios. At a minimum, we expect Congress to enact three sets of policies this year: the infrastructure proposals that already have bipartisan support, the R&D and manufacturing incentives that recently passed the Senate, and extension of the personal tax credits that Congress approved earlier this year. As Exhibit 3 shows, these policies would total around 1% of GDP by 2023, and would cost about $1.6 trillion over the next ten years. At this point, it is difficult to imagine Congress approving less this year.

At the other end of the range of outcomes, it seems unlikely that Congress will enact spending worth more than 2% of GDP on an annual basis. As shown in Exhibit 3, Congress would need to pass nearly all of President Biden’s proposals to reach this level, or around $4.25 trillion over the next ten years.

The uncertainty is mainly related to new benefits for child care, education, and paid leave under the “American Families Plan” as well as the remaining areas of infrastructure that any sort of bipartisan infrastructure deal would likely omit. These areas depend most on the use of budget reconciliation legislation, as it seems very unlikely that any of the proposals would attract much Republican support.

That said, even if Congress enacts nearly all of President Biden’s proposed policies, fiscal support will diminish substantially from 2021 to 2022. Exhibit 4 shows the deficit effect of legislation enacted since the pandemic began, as well as the fiscal effects of President Biden’s proposals using our own categorization.

Q: How much will legislation this year increase spending?

We think the overall boost could amount to $2.5 to $3 trillion over the next ten years. Assuming congressional Democrats take advantage of the reconciliation process to pass fiscal legislation, there will still be two constraints on the amount of additional spending Congress might approve.

Centrist Democrats in the House and Senate are likely to object to legislation that raises the deficit substantially over the next ten years. This will become relevant in the next few weeks, when Congress considers its budget resolution. To use the reconciliation process, the resolution must include instructions to the relevant committees to increase the deficit (or alternatively to increase spending and increase taxes) by specific amounts. The deficit impact of the reconciliation bill that follows will be limited to those amounts. It is extremely unlikely that any Republicans will vote for the Democratic budget resolution, so every Democratic senator and virtually every Democratic member of the House will need to vote for the resolution. It is not yet clear how much deficit expansion Democrats will be willing to support, but we expect centrist Democrats to draw the line at somewhere around $1 trillion. For context, President Biden’s recent budget submission to Congress proposed increasing the deficit by $800bn over the next ten years.

Assuming a limit on the overall amount of deficit expansion, the amount of tax increases and other budgetary savings that lawmakers can agree to will determine how much they can increase spending. At the moment, we expect that Congress might be able to agree on around $1.5 trillion in budgetary savings, nearly all of which could come from tax increases, as discussed later. If so, a reconciliation bill would be limited to around $2.5 trillion in new spending. However, we expect that some additional spending might be approved as part of other legislation. The American Innovation and Competitiveness Act that recently passed the Senate would authorize up to $250bn in spending (around $200bn of this appears to be new money that does not overlap with existing spending). Most of the proposals are similar to policies in President Biden’s American Jobs Plan. However, much of this spending would depend on future Congresses to appropriate, making the overall amount somewhat uncertain. Similarly, a narrow infrastructure bill that passes separately from the larger reconciliation bill might add somewhat to the total. Overall, if Congress approves a reconciliation bill of around $2.5 trillion over ten years, this suggests a total bump to spending approaching $3 trillion over that period.

Q: Will taxes increase?

Assuming Congress passes any legislation using the reconciliation process, tax increases still seem likely. Any bipartisan agreement on infrastructure or competitiveness is unlikely to include meaningful tax increases. If those bills pass and reduce support for subsequent reconciliation legislation, it is conceivable that Congress could fail to enact any tax increases this year, or before the mid-term election in 2022. However, this scenario looks fairly unlikely.

Instead, we assume that Congress will pass around $1.5 trillion in tax increases over the next ten years, as outlined in Exhibit 5. A corporate tax increase still seems fairly likely, in our view, with a rate of around 25%. Some of the other international corporate provisions the Biden Administration has proposed also look likely to pass, though we expect the specifics to diverge from the Treasury proposals. Despite the recent attention a global minimum tax has received, we expect Congress to focus instead on revising the existing GILTI tax, which serves a similar purpose. We do not expect Congress to pass the separate minimum tax on book income that the Administration has proposed, as it looks unlikely to win unanimous support among Democrats and would add complexity without generating substantial revenue.

On the individual side, we continue to believe a capital gains tax increase is slightly more likely than not, though we expect it would rise only to 28% rather than the ordinary income tax rate. It also seems fairly unlikely that Congress will adopt the Administration’s proposal that unrealized capital gains should be taxed at death, as there has already been pushback among centrist Democrats against the concept.

Q: When will all of this happen?

We expect a budget resolution to pass in July, a narrow infrastructure bill in September, and reconciliation legislation in Q4. As noted earlier, before they use the budget reconciliation legislation to pass a fiscal package, congressional Democrats will first need to pass a budget resolution. We expect the details to become clear over the next few weeks, with passage ahead of the congressional recess that starts August 6.

In September, we expect Congress to focus on other issues. First, some type of infrastructure legislation seems likely to pass by late September ahead of the Sep. 30 expiration of the highway program. A short-term extension is possible absent an agreement on a long-term extension.

Second, Congress will need to extend spending authority for the rest of the federal government past September 30, the end of the fiscal year. At this point, a short-term continuing resolution looks likely, which will leave longer-term decisions until late in the year. The risk of a government shutdown around this deadline is low, in our view.

Third, Congress will need to address the debt limit. We expect that Congress will need to raise the limit by early October, with a chance it might need to be raised in September. In theory, this could be done as part of a reconciliation bill (either the large reconciliation package we expect Congress to consider, or a standalone bill dealing with just the debt limit). However, the debt limit cannot be suspended under the reconciliation process, only raised, and this would involve specifying an explicit and very large dollar amount. Instead, we expect Democratic leaders to pass a debt limit suspension along with the extension of spending authority, though other scenarios are clearly possible.

With those issues out of the way, we expect congressional Democrats to attempt to finalize a fiscal package in Q4. It is possible that the legislation could be ready for a vote as early as October. However, since essentially every Democrat in both chambers of Congress will need to agree, reaching a final political compromise could take longer. It is entirely possible that it takes until December for Congress to finalize the fiscal package, ahead of the holiday recess at year-end.

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