“How could you just leave me standing, alone in a world so cold?” —Federal Reserve Chairman Jerome Powell to Congress (and Prince)
Last week I wrote about the probability of two separate bills passing into law. The total spending approaches $5 trillion. Whether you are for or against the bills, there is no denying that it’s a massive amount.
I didn’t get into whether I think they’re good ideas. And I don’t think I will today. The politics of each component are nuanced. Many are politically charged. The two bills are both being called “infrastructure” bills. Still, many people are quick to point out that much of the spending doesn’t cover what would traditionally be considered infrastructure. I’ll refer to them collectively as the infrastructure package just for simplicity’s sake, not to frustrate those who opposed them.
I know I’m coming across as someone who doesn’t want to offend one party or another. I can feel that in my words. But trust me, I can list a whole lot of things that, in my opinion, would classify both Democrats and Republicans as muttonheads. To invoke Mercutio: “A pox on both their houses.”
Fiscal spending is authorized by lawmakers. Lawmakers are politicians. It’s hard to comment on government spending without triggering one side of the aisle or the other. And I don’t think that way when it comes to investment portfolios. I must remain objective.
I am less like our politicians and more like the Federal Reserve. The Fed is inarguably non-partisan. Because the Fed is independent and unbiased, we can consider what they’re doing and saying to determine if the government is “getting it right” in terms of spending nearly $5 trillion.
Last year, Federal Reserve Chairman Jerome Powell publicly advocated for and supported fiscal spending under President Donald Trump. The Fed also publicly advocated for fiscal support during the 2008 financial crisis. Both instances required massive fiscal stimulus. It was appropriate for the Fed to encourage the government to act swiftly to stabilize the economy.
The U.S. economy is now performing much better than during those crises. This begs the question: does it even make sense to spend nearly $5 trillion on the infrastructure package? Does the economy need continued support? (Again, let’s put aside our preferences as to exactly how the money should be spent, if at all.)
Many would argue that this isn’t an economic stimulus package. However, it’s worth considering it from that perspective because it makes us think from different angles. Would the economy falter without the additional spending? Will increased tax rates be offset by higher growth? Will passing the bills overheat the economy and further ignite inflation? In other words, if we get something we don’t need, would the unintended consequences have a deleterious effect on our portfolios?
I ask the question again, does the U.S. economy need the support of the infrastructure packages?
Currently, the Fed is exceptionally accommodative, so it would be hard to imagine they wouldn’t support some level of fiscal help via government spending. Or else why would their foot remain on the accelerator?
On July 14, 2021, Chairman Powell testified before the House Finance committee. He said the U.S. was experiencing “strong economic growth supported by accommodative monetary AND fiscal policy.” The emphasis was his. Powell recognizes that fiscal spending was part of what dug us out of the pandemic-induced crater and that it should not be removed.
Since then, he’s been supportive of continued fiscal help, but quiet on the specifics of how it should be doled out. Not opining on the details of how Congress should write laws is not new to Powell, his predecessors, or other Fed officials. With his term set to expire in early 2022, Powell seems even quieter regarding supporting $5 trillion of spending. Doing so would likely put him in favor of the Biden administration and help cinch him another term. However, he understands the importance of a bipartisan Fed and has appropriately not been playing those games.
I suppose it’s less important what the Fed says or doesn’t say, and it’s more important what they do. The Fed knows that a big chunk of the infrastructure bill is all but guaranteed to pass into law. And the rest of the package is likely to pass, in one form or another. Yet the Fed continues to let easy money flow.
On August 27, 2021, the Fed (virtually) held their annual Jackson Hole, Wyoming symposium. The Fed hinted that tapering their monthly purchases of $120 billion of bonds could start at the end of this year. Nonetheless, Powell’s overall assessment of the meeting’s outcome was very dovish.
Again, Powell reiterated the transitory nature of currently high inflation, arguing that it is no reason to pull back on stimulus. It is the Fed’s position that continued supply chain issues are temporarily pushing up prices. Powell doubled down by arguing that the global disinflationary pressures, which have been around for a quarter-century, will reassert themselves.
Powell was also dovish on the labor market, pointing out that we have a long way to go to get the U.S. back to full employment. Powell did an excellent job divorcing the taper conversation from the rate hike conversation. He made an explicit statement separating the timing of the taper and the trajectory of any interest rate increases. He stated that the Fed would not raise rates until the economy is close to or at full employment. That part is important for the stock market. In 2013, then-Fed Chair Bernanke didn’t do as good a job explaining that there is a higher standard for rate hikes than for tapering. Consequently, the stock market suffered a “Taper Tantrum.”
The Fed’s actions are helpful in determining if it makes sense for Congress to keep spending money as we emerge from a deep recession. The Fed is dominated by economic considerations, not political interests. It continues to push the economy higher even if it knows that Congress will likely pass these giant packages. This means the Fed welcomes the fiscal support (even if I don’t want to say so.)
Let’s face it: Congress often puts together oversized fiscal packages based on ideological preferences. That’s true for Democrats and Republicans and would be true for other parties. We all know it. The shape of the fiscal package is probably politically motivated, but does that make it a bad idea? Does it mean that financial support is not required?
Well, according to The Fed, which removes ideology from the discussion, spending more money may not be a bad idea.
But is that the only question that should be asked? Maybe the question needs better context, like, how will it be paid for?
If the capital gains rate jumps to the same rate as ordinary income taxes, I don’t want any part of this infrastructure package. That would hurt me, my clients, anyone who owns stocks, and small business owners. It’s a horrible idea. And not just because it hurts me, but because a smarter Congress would find a smarter solution. I have one for them.
If we must spend $5 trillion, can we at least get Charles Rettig to help write the part of the law that says how we’ll pay for it? Rettig is the commissioner of the Internal Revenue Service (IRS). According to him, as much as $1 trillion a year in federal taxes goes unpaid because of errors, fraud, and lack of IRS personnel resources to enforce collections. And the Senate knows this because Rettig told the Senate Finance Committee on April 13, 2021.
We don’t need higher taxes when Congress can help the IRS force people to pay their fair share. The solution isn’t to make honest people pay more. Come on, Congress! Do better!
Heck, some estimates of poor collection on cryptocurrency transactions and foreign-source income put the tax payment gap projection at $7.5 billion over the next decade. If the politicians want to do their jobs and give the IRS the tools to do theirs, the U.S. could spend another $5 trillion with fewer problems.
Credit where credit is due — at least in the 2022 fiscal budget, the IRS will receive about a 14% increase in its funding. It’s better than nothing. However, the return on investment is so significant that I still don’t understand why more isn’t allocated to tax collection. The IRS estimates that it could collect an additional $5–$7 in revenue for each added dollar spent on enforcement.
Maybe the question isn’t whether spending $5 trillion makes sense. Perhaps the real question is, why isn’t Congress smarter about how they pay for the spending?
This article originally appeared in The Berkshire Edge on September 7, 2021.