Obama tax plan is good news for US equities
In his push to get businesses to start spending their piles of cash, US President Obama has expressed regret for painting corporate America as the ‘bad guy’. He now looks set to win Congressional backing for his economic stimulus plan, which includes an extension of all Bush-era tax cuts. The plan, which is widely expected to pass through Congress within days, would result in an increase in our 2011 US GDP forecast from 2.5% to a range of 3-4%, with consensus estimates also likely to rise by a similar amount. This is positive for equities in both absolute terms and relative to Treasuries.
Using our model detailed in our 25 June Daily Theme – Earnings forecasts still too high, but valuations remain attractive – an increased in GDP growth forecasts to a range of 3-4% would boost our expectation for earnings growth from 12% to 16%-20%. This suggests that the 13% consensus forecast is too low and likely to be upgraded.
The $858 billion package would extend all of the Bush-era income-tax cuts, set to expire at the end of the month, for another two years. It would also maintain the reduced rate of 15 percent on capital gains and dividends and set new estate tax parameters. The plan passed its first major hurdle in the Senate Tuesday and the House of Representatives is expected to give the final nod.
Other initiatives aimed at boosting corporate spending include two-year extensions of the federal research and development tax credit and a measure allowing businesses to write off investments in equipment, or ‘accelerated depreciation’. This could potentially provide a boost to sales at equipment makers. Corporate tax breaks make up a disappointing 9% of the total package, but are a potential catalyst for job creation.
The plan would also extend unemployment benefits through the end of 2011, allowing workers to collect for up to 99 weeks. For those with lower incomes, child tax credits of $1000 per child under 17 and the Earned Income Tax Credit were also extended.
The largest benefit for the middle class comes from maintaining the cut in income taxes, but social security taxes were also reduced from 6.2% to 4.2%. While some of these tax cuts will be offset by the expiration of others, take-home pay will increase, providing a likely boost to consumer spending.
Income-tax cuts for those earning over $250,000 annually were also extended, while estate tax will be capped at 35%, after the first $5 million, rather than rising to 55% when the Bush-era cuts expire.
More business-friendly policies are likely to boost CEOs’ confidence and encourage them to invest their large cash piles. This should be reinforced by the boost to consumer spending from extending cuts to the lower and middle-income tax brackets.
We believe this is a positive development for the overall economy, which is reliant on the private sector as the government and consumers continue to work off their excess debt. It’s good news for the corporate sector too. The plan reinforces our preference for equities over Treasuries, by punting fiscal consolidation further out on the horizon and boosting expectations for growth and inflation.
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