MIKE TOWNSEND: A lot of words have been used to describe the current Congress. Polarized. Bitterly divided. The "do nothing" Congress.
But over the summer, the "do nothing" Congress suddenly became the "do a whole bunch of things" Congress. In a matter of weeks, bipartisan majorities came together to pass the first significant gun legislation in 23 years, support the entry of Finland and Sweden into NATO, approve landmark veterans' health care legislation, and pass a sweeping $280 billion bill to support the U.S. semiconductor industry and boost spending for scientific and technological research to help the U.S. compete with China.
And in August, Democrats used a special set of rules to pass the Inflation Reduction Act, a $750 billion bill focused on climate change, health care, taxes, and deficit reduction. It was the culmination of a year's worth of stops and starts as Democrats tried to pass a significant economic bill without the support of Republicans.
Just down Pennsylvania Avenue at the White House, August saw one other notable summer development when President Biden announced his long-awaited plan to forgive as much as $20,000 in student debt.
Now that the dust has settled on an unusually productive few months in Washington, it's time for investors to assess the opportunities that may emerge from these new laws.
Welcome back to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to.
Coming up in just a few minutes, I'll drill down into the flurry of recent policy developments in Washington and discuss the implications for investors in four key areas.
But first, a quick look at couple of the issues making news right now.
Both the House and Senate are back in session this week, following the annual August recess―and both parties are eager to get through their business in the next three or four weeks so that they can get on the campaign trail in advance of November's midterm elections. While there are likely to be several significant votes in the next three weeks, possibly including a Senate vote to codify same-sex marriage, Congress really has only one big issue that absolutely has to be resolved before the end of the month. They must address the expiration of government funding on September 30.
The government's fiscal year begins on October 1. Each year, Congress is supposed to pass the 12 appropriations bills that fund every federal agency and program by that deadline. If they don't, that's when a potential government shutdown comes into play. This year, Congress has passed exactly zero of those appropriations bills, so lawmakers will need to pass a temporary extension of government funding, known as a "continuing resolution," by September 30 in order to avoid a shutdown.
The reality here is that the risk of a government shutdown at the end of this month is virtually zero. Neither party has any interest in shutting down the government less than six weeks before the election. So negotiations are underway to kick the can down the road by extending funding through mid-December. Congress would then have to deal with that new deadline when it reconvenes after the election for what is known as a "lame duck" session. No matter what happens in the election, Democrats will still be in the majority when that happens. But the election outcome could make those negotiations tricky if Republicans know they will be taking over the House or the Senate in January 2023.
Congress will also need to decide whether to include a White House request for emergency spending in the agreement to keep the government open and operating. President Biden recently asked for about $47 billion in emergency funds. The White House proposal would allocate those funds to four areas: additional aid for Ukraine in its ongoing war with Russia; more money for Covid testing, vaccines, and treatments; funds for combatting monkeypox; and money for recent disasters, including the August floods in Kentucky and western wildfires. There is broad bipartisan support for the Ukraine aid and the disaster relief. But many Republicans object to the additional funding for Covid and monkeypox, arguing that there is unspent money already allocated for the pandemic. They may force a reduction in the size of the emergency spending package before agreeing to extend government funding. While those details still need to be worked out, the prevailing sentiment is that Congress will pass an extension of funding by the end of the month.
Meanwhile, all eyes will be on the Federal Reserve as the Fed Open Markets Committee meets next Tuesday and Wednesday to discuss another interest rate hike. Fed officials have spent the last few weeks sending signals that another 75-basis-point hike is coming, following June and July rate hikes of the same size.
Fed Chair Jerome Powell used his August 26 speech at the annual Fed conference in Jackson Hole, Wyoming, to reiterate his commitment to raising rates enough to lower inflation from its 40-year highs, even if that results in an increase in unemployment and other "pain" in the economy.
Last week, Fed Vice Chair Lael Brainard and Vice Chair for Supervision Michael Barr both gave speeches in which they echoed Powell's comments about inflation being the Fed's primary target. While none of the officials formally committed to a 75-basis-point rate hike next week, that seems to be the consensus―and even more so after this week's disappointing inflation report showed that inflation is remaining persistently high. Several Fed officials have hinted that a 4% interest rate by the end of the year may be the goal. With the current rate at between 2.25% and 2.5%, and three Fed meetings to go before the end of 2022, a larger rate hike next week would mean the Fed could start to scale back the rate of increase at the final two meetings of the year.
On my Deeper Dive this week, I want to take a closer look at the implications of some of the recent policy developments in Washington with a focus on four areas that investors should be aware of.
There's a lot to get to, so let's start with the Inflation Reduction Act. The bill, which passed the Senate and then the House in early August, was signed into law by the president on August 16. It followed a long and twisting path to that moment―what began almost exactly a year ago as a more than $3 trillion package that was known as the "Build Back Better Act" went through 12 months of fits and starts, including several months when it seemed absolutely dead in the water, to evolve into a much more narrow but still significant piece of legislation.
The largest portion of the Inflation Reduction Act is focused on combating climate change. The $369 billion of clean energy and climate-related provisions is the country's largest-ever investment in climate change, setting a goal of reducing carbon emissions by 40% by 2030.
There's a wide variety of initiatives, from helping to make manufacturing processes greener to boosting domestic production of solar panels and batteries to funding clean energy school buses and garbage trucks to supporting reforestation. These initiatives are likely to be good for electric vehicle manufacturers, for companies that make things like solar panels and wind turbines, as well as companies that specialize in energy storage.
But there are two high-profile tax incentives for individuals that I think are particularly worth noting. The first is a set of tax credits for homeowners who make energy-efficient improvements to their homes by installing new windows, heat pumps, appliances, or solar panels. The new law vastly expands existing tax credits so that homeowners can claim up to 30% of all the costs for eligible home improvements during the year, up to an aggregate limit of $1,200 in credits. If you spread out your home improvements over multiple years, you can claim the maximum tax credit each year.
The other one is the one that has been getting a lot of attention in the media: the $7,500 tax credit for the purchase of an electric vehicle.
If you are considering purchasing an electric vehicle, you really have to pay attention to the details on this new tax credit. First of all, there are income limitations for being eligible―if you are single and earn more than $150,000, or if you earn more than $300,000 as a couple, you're not eligible for the tax credit.
Second, there are caps on the price of the vehicles that are eligible―$55,000 for cars and $80,000 for trucks, vans, and SUVs.
But most importantly, there are restrictions on which vehicles are even eligible. They have to be assembled here in the United States, which means certain cars made by companies like BMW, Hyundai, and Kia are not eligible. In addition, the batteries and the key minerals for the batteries need to be sourced and manufactured in the United States or in a country that's a trade partner of the U.S. Today, the vast majority of minerals and battery components are sourced from China, which makes any vehicle using those materials ineligible. As a result, the majority of electric vehicles on the market today won't be eligible for the tax credit when it goes into effect in January, and it may be a couple of years before most EVs are eligible.
So it's really important to do research before you buy to see whether the vehicle you want to purchase is eligible for the tax credit.
The second part of the bill for investors to focus on is taxes. As this bill evolved over the past year, it's been a real rollercoaster ride in terms of what's in and what's out when it comes to tax increases.
In last year's original version of the bill, the tax changes were focused on wealthy individuals. That initial draft included things like an increase in the top individual income tax rate, a new capital gains rate, changes to the estate tax, and more.
All of those provisions were eventually tossed aside, and last fall there was a flurry of interest in various proposals for a wealth tax on the highest earners. But of course the bill collapsed at the end of 2021 in the Senate, so nothing happened.
When the bill came back to life over the summer, the focus had changed to corporate taxes. The legislation that passed Congress last month contained no tax increases that directly apply to individuals.
Instead, the bill features two big corporate tax changes―both of which have potentially huge implications for investors.
The first is a new 15% minimum tax, which applies to corporations with more than $1 billion in annual profits for a three-year period. If they are effectively paying less than 15% in taxes on their book income, starting next year they'll have to pay 15%. Think of it like the Alternative Minimum Tax for individuals, which ensures that wealthier filers can't use investment losses and various tax credits and deductions to reduce their tax liability too much.
There are about 100 companies in the S&P 500® that could fit into this category. According to the Joint Committee on Taxation, the provision is expected to raise more than $220 billion in revenue over the next 10 years. Various reports have indicated that tech companies like Amazon, Intel, Meta, and Nvidia would see increased tax bills under the new rules, as well as other kinds of companies, like Verizon, UPS, General Motors, and Bank of America.
From an investing perspective, however, the tax bills of these companies may not materially impact their overall earnings or change their behavior. And, of course, the tax burden of a company is just one of numerous factors that play into a company's share price. This is something we'll be watching in the coming years to see how it impacts the affected companies.
The second piece is a 1% tax on stock buybacks. That will kick in on January 1, so there could be a flurry of buybacks between now and the end of the year, as companies seek to do any buybacks before the tax takes effect.
Stock buybacks are popular with investors because they raise the share price. In the first half of 2022, S&P 500 companies repurchased more than half a trillion dollars' worth of shares. The 1% tax would apply to net buybacks, which are the total number of shares repurchased minus the number of shares issued during the year. It is projected to raise nearly $75 billion in tax revenue over the next decade.
A recent study found that Apple would have owed about $900 million in taxes if the 1% tax had been in effect in 2021. The same study showed Meta, the parent of Facebook, and Alphabet, the parent of Google, would have each owed about $500 million.
So will the new tax change corporate behavior? It's too early to tell of course, and the early reaction has been mixed. For a company like Apple, which reported nearly $95 billion in net income in its most recent fiscal year, a tax hit of $900 million probably isn't going to dramatically alter its decision-making. And companies have other options. They could, for example, increase their dividend or issue a special dividend. That would benefit investors, but it would also create tax consequences for investors by increasing taxable dividend income.
These two tax provisions are worth keeping an eye on to see how they might affect companies going forward. But, again, no individual tax increases to worry about.
There is one other provision in the Inflation Reduction Act that is tax-related, and it has generated a variety of strong reactions. The new law increases the IRS budget by $80 billion. Opponents have been saying that it will lead to an army of auditors that will descend on the middle class, but that's not exactly what the plans are.
A lot of that money will be used to hire more employees to help the IRS dig out from a backlog of about 20 million unprocessed tax returns and also to improve customer service by, for example, increasing the number of people available to answer the phone. Last year, it was estimated that less than one of every 10 calls to the IRS was answered.
Money will also be used to upgrade the agency's notoriously outdated technologies.
Over the next few years, the focus will turn to enforcement, which likely will mean more auditors are hired to focus on high earners. The goal is to close the so-called "tax gap," which is the difference between taxes that are owed and taxes that are actually collected. Treasury Secretary Janet Yellen has said that taxpayers earning less than $400,000 will not see any increase in the rate of audits.
The Congressional Budget Office projects that the $80 billion in spending will result in more than $200 billion in additional taxes collected. But you're not going to see a rash of audit notices going out to taxpayers in suburbia.
The third major recent development was the passage of the $280 billion CHIPS Act, which the president signed into law on August 9.
The CHIPS Act includes more than $52 billion in subsidies over the next five years to boost the U.S. chip-making industry. The U.S. share of semiconductor manufacturing capacity in 1990 was 37%. Today it is just 12%. China and Taiwan are responsible for nearly half of all the chips made today. During the pandemic, there was a global crunch in semiconductors because of the supply chain issues and the production dominance of just two countries. But there are already signs that the infusion of federal support will be a key component of turning those numbers around. Last week, President Biden traveled to Ohio for a groundbreaking ceremony on a $20 billion chip-manufacturing plant by Intel Corporation. Micron broke ground earlier this week on a $15 billion manufacturing facility in Boise, Idaho. Taiwan-based TSMC, the world's largest chip manufacturer, is already building a $12 billion plant in Arizona and said last week that it would apply for subsidies under the new law. And other semiconductor plants are also in the works. Asian governments have long supported chip manufacturing with subsidies―now the United States aims to level that playing field.
But there's more to this new law than just support for the semiconductor industry. The bill also adds a whopping $200 billion for scientific and technological research, with a particular focus on cutting-edge fields like artificial intelligence, quantum computing, robotics, space exploration, and the development of the next generation of wireless technology. Some of the money will go to creating partnerships between research universities and the business sector to create 20 regional technology hubs around the country. And money will go to the National Science Foundation and other federal entities to promote research and improve STEM education as part of an effort to develop a robust workforce that has the skills needed for careers in these emerging technologies. It even creates a new federal position, called the Director of Technology and Innovation, that would have responsibility for overseeing the distribution and use of the billions allocated in the new law.
For investors, this may be time to look for opportunities in the technology sector, both in the semiconductor manufacturing space and in companies that are big users of chips, like electric vehicle makers and solar panel manufacturers. Some of these types of companies are double winners―benefiting both from the Inflation Reduction Act's focus on green energy and technology development and the CHIPS Act with its focus on semiconductor production and cutting-edge research and development.
Both of these new laws seek to boost U.S. manufacturing, create U.S.-based jobs, and reduce the dependence on China.
And fourth, a word or two about the president's student loan forgiveness plan. The presidential action essentially erases up to $10,000 in student loans, no questions asked. For Pell Grant recipients, the total amount forgiven can go up to $20,000. There are income limits―only individuals with income below $125,000 or couples earning less than $250,000 are eligible. And the plan only applies to federal loans, not private sector loans. That means it has a huge impact on the federal government, which will lose an estimated $300 billion to $500 billion in repayments that it had anticipated receiving.
Depending on your loan, the elimination of the $10,000 could be automatic―you may not even need to contact your loan servicer. But anyone who anticipates getting the relief should watch their account closely to make sure it is accurate.
The plan has generated strong reactions, both positive and negative, from both sides of the political spectrum. To some, the plan doesn't go far enough. To others, it's a giveaway that has generated plenty of sentiments along the lines of, "Well, I paid my student loans back, why shouldn't everyone else?"
One of the big questions looming over the student loan forgiveness plan is whether it will be challenged in the courts. That seems likely. Loan servicers or financial institutions that are losing income could challenge the plan. Members of Congress who think the plan is an improper circumventing of the legislative branch could bring a challenge. Some state officials have threatened to challenge the plan.
And legal scholars are mixed on whether the plan would prevail in a lengthy court fight. The Biden administration issued an explanation of the legal rationale behind the plan, which relies on an interpretation of a 2003 law that gives the Department of Education authority to help out borrowers in times of national emergency, such as the pandemic. But some analysts believe that the law is being interpreted more broadly than intended.
For now, we'll have to wait and see whether any legal challenges are filed. If they are, it could freeze the program before it even gets started.
Finally, with Labor Day in the rearview mirror, the sprint to the midterm elections in less than eight weeks is fully underway. So what's the state of play?
Well, put simply, the atmosphere has improved significantly for Democrats.
There are a number of reasons for that.
One is that parts of the economy have been improving―most notably, gas prices, which have come down significantly.
Another is that Congress, which is controlled by Democrats, has had this significant run of policy accomplishments that I've been describing.
The Supreme Court decision to overturn Roe v. Wade has also had an effect, galvanizing Democrats and leading to a big surge in voter registrations by women.
All of this has helped the president's approval rating and generally added up to a better environment for Democrats. There were two special elections in August for vacant House seats―one in upstate New York and one in Alaska―and both were won in upsets by the Democrat. Democrats are hoping that's a bellwether for November, though I am always cautious about overthinking special election results.
All of that said, I still think Republicans are favored to take control of the House of Representatives. The margin of that majority may be smaller than was thought a few months ago, and the odds of a huge Republican blowout have come down. But I still think it is likely that Republicans win the House.
On the Senate side, Democrats appear to have a slight edge to maintain their majority and possibly even expand it by a seat or two. There are a lot of really close races to watch. There are extremely close races shaping up in Arizona, Georgia, Nevada, Pennsylvania, and Wisconsin―those five states are likely to determine which party emerges with the majority. Races for Senate seats in Colorado, Florida, New Hampshire, North Carolina, and Ohio could also be close. That's 10 states I've mentioned, any one of which could be the ultimate deciding factor to tipping the current 50-50 tie in one direction or the other.
It's going to be absolutely crazy between now and Election Day in terms of the amount of advertising and campaigning these battleground states will see. I'll be keeping up with all the developments in the weeks ahead and will share insights throughout the fall on this podcast.
Well, that's all for this week's episode of WashingtonWise. We'll be back in two weeks with a new episode. Take a moment now to follow the show in your listening app so you won't miss an episode. And if you like what you've heard, leave us a rating or a review—that really helps new listeners discover the show.
For important disclosures, see the show notes or schwab.com/washingtonwise, where you can also find a transcript.
I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.
