Government Stimulus, Taxes and Your Investments

THE $1.9 TRILLION AMERICAN RESCUE PLAN ACT OF 2021, one of the largest stimulus acts in the nation’s history, offers ongoing pandemic relief while supporting a more level economic playing field for lower-income Americans. In addition to nearly $600 billion in tax relief, the law, signed by President Biden last month, includes direct aid to states and to local governments, billions of dollars for restaurants and other businesses battered by the pandemic, extended weekly unemployment benefits and more.¹

As the money shores up families and businesses and flows into the economy, “this latest round of stimulus could help spur economic growth in the United States,” says Jonathan Kozy, senior macro strategy analyst in the Chief Investment Office (CIO) for Merrill and Bank of America Private Bank. Here, Kozy and other experts from the CIO examine the likely tax and investment implications of the historic act—including both near-term economic benefits and the longer-term risks that government spending could trigger inflation and other challenges.

Benefits for taxpayers

“The vast majority of the Rescue Act’s tax provisions focus on two areas: distributing additional funds to taxpayers and enhancing tax credits for lower-income families with children,” says Mitchell Drossman, national director of wealth planning strategies in the Chief Investment Office for Merrill and Bank of America Private Bank. Building on two previous rounds of rebates in 2020, the new law authorizes up to $1,400 for individuals ($2,800 for married couples, filing jointly) as well as $1,400 for each dependent. Rebates phase out for individuals with incomes higher than $75,000 ($150,000 for married couples, filing jointly) and are not available for those with incomes above $80,000 ($160,000 for married couples, filing jointly).

Among other provisions, the law extends and expands dependent care assistance, a plus for working parents, as well as child tax credits and earned income tax credits. Additionally, students whose federal loans are forgiven, from the end of 2020 through January 2026, will no longer pay income tax on the amount forgiven, as previously required. “For businesses, the law extends and enhances the Coronavirus Aid, Relief, and Economic Security Act’s (“CARES Act”) Employee Retention Tax Credits, encouraging companies to hold onto employees, and extends credits for paid sick and family leave,” says Drossman.² For a full rundown of the Rescue Act’s tax provisions, see the CIO tax alert, “American Rescue Plan Act of 2021.”

Stimulating the economy

For Americans not directly supported by the tax relief, the primary impact may be an expected lift for the economy and the markets. Provisions such as weekly $300 federal unemployment benefits (extended through September 6) and rental and mortgage assistance, as well as funding for vaccinations, testing and schools, to help accelerate reopening, could all add to economic growth.

The government this year is also likely to advance a major infrastructure bill that could jump start projects ranging from bridges and highways to tech infrastructure supporting the digital economy. Spurred in part by such initiatives and expected improvements in the unemployment rate, “the U.S. economy may potentially outperform other developed market economies this year and next,” Kozy believes.³ “BofA Global Research is projecting real gross domestic product to grow 7% in 2021,⁴ compared with 5.8% globally.”⁵

The long-term risks of debt

Yet despite these benefits, the Rescue Act, combined with trillions of dollars of pandemic-related stimulus in 2020 and possible new infrastructure spending, represents a “great debt binge,” posing potential long-term risks for the economy if spending continues unchecked, Kozy states in a new report from the CIO, “The Great Debt Binge.” Risks include a return of inflation and rising interest rates and even a potential weakening of the dollar’s longstanding status as the world’s reserve currency.⁶ “That status enables the U.S. government to finance deficits at lower rates and to use the dollar as a tool in international relations, and it makes it easier for U.S. companies to do business,” Kozy says. “There are few signs that fiscal discipline is right around the corner,” he adds.  “Investors are left trying to navigate the ongoing debt binge.”

What investors can consider doing

 “Bond yields, already on the rise, will likely move higher in the near term as stimulus spending raises expectations for growth and inflation,” notes Kozy. With rising bond rates depressing bond prices (when bonds yields rise, their prices typically fall), economic growth should favor stocks over bonds, though bonds remain an important part of a diversified portfolio, adds Joseph Quinlan, head of CIO Market Strategy in the Chief Investment Office for Merrill and Bank of America Private Bank.

Over the next couple of years, Kozy suggests, “investors may want to consider cyclical stocks, such as industrial companies, the energy sector and financial companies, whose performance tends to reflect ups or downs in the economy.”  Infrastructure spending will likely boost not just traditional industrial companies, but those devoted to renewable energy and electric vehicles, charging stations and batteries. “Given the continued build-out of the global digital economy, we also continue to favor large technology companies, both U.S. and non-U.S.,” Quinlan adds. And, assuming mass vaccinations enable society to reopen, the recovery of battered service industries could present investment opportunities.⁷

Over the longer term, if inflation appears likely to spike, “investors may want to consider assets that tend to rise in value as inflation increases, including real estate, farmland, collectibles and commodities,” notes Kozy.  Commodities, such as metals and other raw materials, may offer a double benefit, he adds. In addition to the inflation hedge they may offer, commodities may benefit from economic growth and expansion in areas ranging from infrastructure to renewable energy.

Yet while it’s important to stay aware of, and prepared for, long-term inflation, keep in mind that any investment decisions should be made in the context of your overall financial needs and goals. “In the end,” says Quinlan, “the best hedge against market cycles and surprises is a diversified portfolio both across and within asset classes. Whatever the year, whatever the crisis, that never changes.”

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