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Thoughts on the Market

Michael Zezas: A Step Forward for Build Back Better


The Build Back Better Act took a key step towards becoming law last week, signaling implications for fiscal policy and taxation as the bill heads to the Senate.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 24th at 11:00 a.m. in New York.

Last week, the Build Back Better Act took a step toward becoming law when the House of Representatives passed the bill along party lines. While the act now still needs to win Senate approval, likely with some substantive changes, there are two lessons that we learned from the House's actions.

First, U.S. fiscal policy will continue to be expansionary in the near term. That's based on analysis from the Congressional Budget Office of the Build Back Better plan, adjusted for some key provisions that likely won't survive the Senate. When added to the analysis of the recently enacted Bipartisan Infrastructure Framework, it shows the combined plans could add around $200B to the deficit over 10 years - close to our base case of about $260B. But more importantly, the analysis suggests most of this deficit increase is front loaded, with around $800B of deficits in the first 5 years - toward the high end of the base case range we flagged earlier this year. This is the number we think matters to the economy and markets, as the durability of the policies that will reduce this deficit beyond 5 years is less certain, as elections can lead to future policy changes. And this number also helps drive some key views, namely our economists' call for above average GDP next year and our rates teams' view that bond yields will continue to move higher.

Our second lesson is that the corporate minimum tax looks like it has legs. The provision, also called the Book Profits Tax, survived the house process largely unscathed. While Senate modifications are to be expected, we expect the provision will be enacted. That means investors will have to get smart on the sectoral impacts of this new, somewhat complex, corporate tax. Our base case is that this won't be a game changer for markets. Our equity strategy team calculates a 4% hit to S&P 500 earnings before accounting for any economic growth. And while some sectors, like financials, appear most likely to have a higher tax bill, our banks analyst team expects most of this new expense can be offset by tax credits. Still, this new tax is tricky and untested, so fresh risks can emerge as the bill goes through edits in the Senate. So, we'll be tracking it carefully into year end.

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