Stimulus … or Stimu-Less?

When the $1.75 trillion budget bill known as Build Back Better reached an apparent impasse in the Senate on Sunday, political spectators got a heavy dose of theatrics—but the US economy did not lose out on “stimulus,” which we think was a misnomer from the start. Love or loathe the proposal, we think these things rarely (if ever) have the economic impact advertised, and pundits regularly overstate their benefits for the economy and stocks. To see the latest example, let us look to the EU, which passed a huge public investment package in July 2020—which hasn’t demonstrably created demand.

At the time, the world hailed the EU Recovery Fund as a landmark “stimulus” package that, in addition to pooling EU nations’ sovereign debt for the first time, would deploy nearly €700 billion worth of new investments over the next five years. That, supposedly, would juice economic growth in the short and long term. To ensure this, the fund’s regulatory framework stressed that “EU funds should be used to the Union’s overall benefit and/or in line with EU priorities and do not replace national spending that Governments would, anyway, implement.”^[i] (Boldface ours.)

That seems crystal clear. But new research from the European Network for Economic and Fiscal Policy Research, known as EconPol Europe, suggests this hasn’t gone according to plan. Instead of launching new projects, Germany, Austria and Spain allocated “the largest share of their grants to finance projects that were either already planned or to extend/continue projects that were already existing.”^[ii] In other words, these nations swapped EU money for national funds they would have spent anyway. It was an accounting maneuver, not stimulus.

Obviously, these two situations are different. The US isn’t the EU, and the EU Recovery Fund’s focus on green and digital investments technically has more in common with last month’s infrastructure bill than Build Back Better. But the same general principle applies, in our view: When it comes to big public spending bills, the implementation and details often don’t match the sweeping claims that accompany the legislation. We saw this with the infrastructure plan, billed as a $1 trillion investment package even though only about $550 billion represented new spending. That spending is also set to trickle out over many years, making it entirely possible future Congresses could amend those budget line items, reallocating or cutting that projected spending over time—a vulnerability Build Back Better would have shared. That, in our view, is a striking parallel with those EU nations’ budget tricks.

Politicians in both parties often sell big multiyear budget packages to voters as if they are guaranteed to play out exactly as the initial legislation outlines. But every budget is a multiyear package, and line items change all the time. In 2017, the Republicans’ tax reform legislation scheduled the $10,000 cap on state and local tax (SALT) tax deductions to expire in 2025. Build Back Better would have raised that cap to $80,000 through 2030, then making a $10,000 cap permanent from 2031 on. Does anyone think it wouldn’t have been tweaked again? And again? As for the spending side, remember the Sequestration budget cuts passed in 2011? Those capped discretionary spending from 2013 through 2021, contributing to the dreaded fiscal cliff in 2012. They took effect after a one-year reprieve, yet discretionary spending has far exceeded the initial caps every year the sequester has been in effect.^[iii] Turns out those “forced” cuts weren’t so forceful—Congress raised the cap four times.^[iv]

Every line item on the Federal budget is a line in the sand, easily wiped and redrawn, not a stone carving. Markets know this, which we think is a big reason stocks don’t have big pre-set reactions to tax and spending changes. When fiscal policy is in permanent flux, there isn’t much point in getting hung up on potential changes.

In our view, the notion that Build Back Better or any of the recent spending packages would magically multiply economic activity is a fallacy. Much as technocrats in both parties love the idea of directing investment and pulling levers to speed growth, ours is a private sector-led economy. Setting aside the sociological implications, which we think stocks see through, more public spending risks crowding out private spending and investment, which isn’t automatically a net economic benefit. Even transfer payments don’t have a huge impact on consumption, as demonstrated by how many households saved their COVID relief payments instead of spending them. Consumer spending didn’t suddenly accelerate once the Treasury started mailing out child tax credit payments over the summer. Instead of viewing fiscal policy changes in terms of “stimulus,” we suggest sizing them up for the potential winners and losers they create instead.