High-income tax states like Massachusetts, New Jersey, California, and New York would appear to be winners if President Biden's "Build Back Better" plan is finally passed by Congress. The Trump-era limit on state and local tax deductions could provide a $200 billion (or more) wind fall for wealthy Americans.

 

As it stands now, congressional Democrats, especially those who represent high tax states, are crafting a change in the SALT deduction cap. Presently American households can only deduct $10,000 of state and local taxes from their federal income taxes. That cap deduction is poised to end by 2026.

 

In a prior column, I explained that in exchange for their votes on Biden's $1.7 trillion plan, high tax state legislatures insisted on lifting the amount of the SALT cap. The House Rules Committee is now working on a change that would raise the $10,000 cap to $72,500 for five years (that would be retroactive to 2021).

 

The largest beneficiaries, according to the Tax Policy Center, would be households earning at least seven figures. They would receive the lion's share of benefits. As for middle-income U.S. households, the average cut in taxes would only amount to roughly $20 per year, while the higher income earners would be saving $23,000 per year. 

 

A full 25 percent of the tax cuts would flow to the top 0.1 percent of taxpayers. For them, the average savings in taxes would be $145,000. Another 57 percent of the benefits would go to the top 1 percent, who would save roughly $33,100 annually.

 

The Committee for a Responsible Federal Budget, a non-partisan, non-profit economic education organization, believes the tax benefit would cost $300 billion over the next four years with $240 billion of that cost accruing to those who make more than $200,000 a year. That would put the price tag for the SALT cap expansion on par with childcare subsidies, and the clean energy tax credits, making it the third costliest element of the overall Biden plan.

 

The legislation puts Democrats between a rock and a hard place. Clearly, most of the benefits would be going to the bluest-of-the-blue coastal states. The fact that it also benefits the wealthiest Americans flies in the face of the progressive side of the party, who have stomped and won their seats railing against income and wealth inequality.

 

In order to pass the Build Back legislation, Democrats need all hands-on deck. But the group of legislators most impacted by the present SALT tax has made it clear that without a SALT deal there would be no deal on the overall Biden plan. 

 

Over in the U.S Senate, key players are backing a different approach. They want to exempt taxpayers from the SALT cap, who make under a certain income level. That level is still being debated.  Achieving a resolution between the House and the Senate will be necessary before Democrats can hope to send a new version of the budget reconciliation package to the White House.   

 

In the middle of the debate sits the president. The framework of President Biden's plan, released last week, did not include a SALT repeal, or change in the present tax cap. In the past, however, the president has indicated he might be open to eliminating the deduction cap altogether. 

 

My own guess is that the Senate approach, which favors an income-based exemption, would be more palatable to a voter base that would not be interested in giving the wealthy another huge tax break.    

 

Rising prices at the gas pump, combined with soaring shopping bills at the supermarket, are having a noticeable impact on the consumer's pocketbook. But what's worse is that higher prices in oil beget higher prices in food in the future. Here's why.

 

Historical economic studies tell us that energy prices have a significant impact on food prices with 64.17 percent of changes in food prices explained by the movement of oil prices. But that only tells half the story. As energy prices climb, inputs to farm production are also impacted. Fertilizers, for example, account for between 33 percent to 44 percent of operating costs. 

 

The production of fertilizer and its inputs (such as nitrogen, phosphate, and potash) requires substantial amounts of energy, which increase the selling costs to farmers. Fertilizer prices are now the highest in decades. To make matters worse, the prices of fertilizer and its inputs continue to see dramatic increases, rising as much as 18 to 26 percent during the last month alone.

 

Obviously, energy in the form of diesel, gasoline, and electricity is also a direct input cost to the agricultural sector. It is critical to running and maintaining the myriad machinery required to plant, grow, harvest, and transport food products to market.

 

In addition, the explosion of greenhouse growing of vegetables has also been hit hard by higher energy costs. That is no surprise, since this is an extremely energy-intensive area. And as energy prices continue to climb, more farmers have shut down their greenhouses, reducing crop production even further.

 

Higher energy prices have also prompted farmers to switch more of their fields from food production to making biofuels. As more and more acreage are switched to soybeans and corn (key inputs in biofuels), there is less acreage devoted to other crops. That leads to less supply and higher prices for everything from wheat to livestock feed.  

 

The United Nations index of food costs has climbed by a third over the past year. This has led to a decade-high jump in global food prices at a time when the world is contending with its worst hunger crisis in 15 years. As readers may be aware, this energy/food issue is being aided and abetted by worker shortages, supply chain issues, and weather calamities such as flooding and drought. This is particularly bad news for poorer nations that are dependent on imports.

 

It is currently harder to buy food on the international market than in almost every year since 1961, which is when the U.N. record keeping began. The only exception was the period 1974-1975. That is no coincidence, since the OPEC-driven oil price spike of 1973 spawned the rapid inflation that impacted food prices.

 

To give you an idea of how food stuffs are climbing throughout the globe, in September 2021, alone, the U.N. food index rose 1.2 percent. Grains jumped 2 percent, driven by wheat, which has been hit by drought in North America and Russia, the world's largest producers. Sugar, a big Brazilian export, also saw big price gains. These price hikes are boosting import bills for buyers around the world. Competition for additional food supplies is also adding upward pressure to prices as well.

 

Most of us here in the United States are at least able to afford the twin increases in fuel and energy for now. However, there is a time lag between the recent price spikes in the oil and agricultural markets and how long it will take to filter through to grocery stores. In the meantime, keep an eye on the oil price as an indication of where your grocery bill will be going into the weeks and months ahead.

 

The Federal Reserve Bank signaled an all-clear for the financial markets this week. The tapering they promised will begin on schedule, but Fed Chairperson Jerome Powell has no plans to raise interest rates until at least some time next year.

 

The announcement was met with relief. Investors reacted by catapulting the stock market to yet another higher high. Bond traders were somewhat mollified, as well as seen by the lack of movement in interest rates. If anything, Chair Powell was a bit more dovish than investors expected.

 

He surprised markets by reducing the size of the monthly taper, which will begin later this month. At present, the U.S. Central Bank is buying $120 billion a month in assets. Investors were expecting a $20 billion monthly reduction in purchases, but the Fed decided to reduce those purchases by only $15 billion a month.

 

It appears that the rate of inflation is still not serious enough for the Federal Reserve to move forward their expectations on raising interest rates. Next summer is the earliest Powell sees a need to raise interest rates. However, he did admit that he expects the conditions that are pushing inflation higher could persist well into next year. 

 

His stance is similar to the position already taken by the European Central Bank (ECB). The ECB expects to continue its easy money policies into next year. But while most of the developed world is applying the momentary brakes ever so gradually, many emerging market countries are already raising interest rates to head off rising inflation in their economies. Chile, Russia, and Brazil, for example, have hiked interest rates recently. Of the 38 central banks followed by the Bank for International Settlements, 13 have raised a key interest rate at least once this year.

 

Investors are paying close attention to the stalled situation surrounding the two large Biden infrastructure bills after the resounding thrashing the Democrats suffered this week in various elections. Voters seem to be increasingly unhappy with what they perceive as their "do nothing." President Biden's approval ratings are dismal, and time is running out to reverse the situation before the mid-term elections.

 

It remains to be seen whether this week's election results will spur this fractured party to come together and start legislating or sink further into disarray. The House is expected to vote on at least one if not both bills on Friday, Nov. 5.

 

There is a lot riding on the outcome for the economy and the markets. And while the price tag for both bills is high, as a percentage of GDP, in reality the expenditures are a drop in the bucket when compared to what other countries are spending on their own infrastructure plans. Is it any wonder that China sees us as no more than a "paper tiger," whose politicians lack the will to compete in the areas that really matter?

 

Earnings season is winding down, but once again the results defied even the most bullish of expectations. That bodes well for stocks. More and more sectors are participating in the upturn and there doesn't seem to be many storm clouds on the horizon until we head into December, if then. This week's decline in oil may also act as a tailwind for stocks. Higher energy prices have been leading inflation higher for the last few months. If oil pulls back from here, or just remains in a trading range, equities could get a boost from that as well.

 

To me, however, the most important event of the week was drug company Pfizer's announcement that Paxlovid, a COVID-19 pill, reduced the risk of hospitalization or death by 80 percent in a clinical trial that tested the drug in adults with the disease who were also in high-risk health groups. 

 

Pfizer CEO and Chairman, Albert Bourla, said, "These data suggest that our oral antiviral candidate, if approved or authorized by regulatory authorities, has the potential to save patients' lives, reduce the severity of COVID-19 infections, and eliminate nine out of 10 hospitalizations." To me, this pill could be a game changer for the economy and for people all over the world. It is possible that we could see the coronavirus battle won by sometime next year.

 

I have been expecting a shallow pullback in the markets for the past two weeks. Instead, stocks have just climbed higher and higher. They are extended, but history says they can get even more so. As such, I am not holding my breath, nor waiting around for it. Whatever pullback does occur should be bought.

 

Third-quarter earnings have cheered investors, sending markets to new highs. The bullish wave of buying was so strong that investors ignored the disappointing third quarter read on the nation's Gross Domestic Product (GDP).

 

Economists were looking for the economy to grow by 2.6 percent, but instead, GDP gained a mere 2 percent, which was the slowest rate in over a year. Economic activity was damaged by the Delta variant as well as continuing supply-side constraints. The market's reaction indicates that investors are looking through the weak number and expecting the economy to continue to grow.

 

It seems to be a question of demand versus supply. Yes, the economy slowed, but it wasn't because demand is slowing. It was simply a matter of supply chain bottlenecks that are forcing pent-up demand further into the future.

 

As we close out this week of earnings the "beat" rate of corporations is more than 80 percent. Most of the big mega-cap technology companies (with some exceptions) have once again delivered good results, which has kept the markets buoyed. Managements continue to complain about supply constraints and higher prices, which are compressing profit margins in some sectors, but not enough to really hurt overall results.

 

As for the Fed, next week on Nov. 3, the long-awaited FOMC meeting will occur and with it the expected start date of the tapering of asset purchases. It seems to me that the Federal Reserve Bank and its Chairman Jerome Powell have done everything in their power to prepare the markets for the onset of tapering. It remains to be seen how the markets will react to the actual implementation of tapering. We could see some nervousness leading up to the meeting.

 

But the new topic of conversation — a rise in interest rates. When will the Fed start raising interest rates from the near-zero levels at present? Some traders believe that interest rates will be hiked faster than most investors are expecting. Rising inflation is the impetus behind that conviction. Persistent and accelerating inflation is the biggest risk to the market right now, in my opinion. If the inflation rate continues to gain, investors would worry that the Fed might be forced to raise interest rates by as many as two hikes next year, and three in 2023. That would most likely create severe negative repercussions for the stock market. 

 

Democrats are struggling to compromise on some version of an infrastructure bill with President Joe Biden urging House Democrats to accept a scaled-down version of his Build Back Better proposal. This week, the package would amount to $1.75 trillion versus the $3.5 trillion he originally requested. Progressive Democrats would have to agree to jettison pet projects such as paid family leave and expanded Medicare coverage of vision and dental for elders. Both of which were popular with voters and a priority for several woman lawmakers. A 15 percent minimum corporate tax, a 50 percent minimum tax on foreign profits of U.S. corporations, tax hikes on the highest income Americans, and possibly a surtax on multimillionaires and billionaires are still on the revenue raiser list.   

 

As for stocks, most markets are extended. That may mean we see some profit-taking during the next week. I am not looking for anything serious, maybe a 2-3 percent spate of selling (at most) that might take us into next Wednesday's FOMC meeting on November 3, 2021.

 

My own bet is that investors will like what Chair Powell will say, and if so, we could see another leg higher for the markets. If Congress does come through with an infrastructure compromise bill, the markets would get a lift. As such, I would use any dip to add to equities. After that, I think we have smooth sailing into the end of November.

 

This week, the Democrats unveiled a new plan to finance President Biden's "Build Back Better" legislation. That proposal, along with a 15 percent corporate minimum tax, has politicians scrambling to line up for or against the idea. Does it have a chance to pass?

 

Credit for the idea goes to the Senate's top tax expert, Finance Chair Ron Wyden, an Oregon Democrat. His plan is to target only people with $1 billion in assets, or who are earning more than $100 million over three consecutive years. This group would be required to pay capital gains taxes each year on the appreciation in the value of their assets. It won't matter whether they sell or hold those assets.

 

The plan would impose a one-time tax on all the gains accumulated before the tax was created. That could mean a huge tax bill for some entrepreneurs that still hold a sizable portion of their company in stocks, bonds, etc. These founders would have five years to pay off their one-time tax. Each year after that capital gains taxes would be levied on the annual appreciation of assets that are easily valued such as publicly traded assets (bonds and stocks). Ownership of private companies and real estate holdings might not be assessed until after they are sold with different tax rules, depending on the nature of the assets.

 

The beauty of this plan for politicians on both sides of the aisle is that if passed, the billionaire tax would only impact around 700 people. As such, there is not a lot of voter risk involved in this idea. But the upside would be that it would generate several hundred billion dollars in revenues. Capital losses on assets would be allowed, which could also be carried forward (and in some cases backwards).

 

For those who might oppose this plan, the idea of defending a bunch of billionaires is dicey at best. Most voters (and most of the media) believe this wealthy handful of people are not paying their "fair share" of taxes in the first place. And as for the corporate tax rate, most large corporations are not paying the official tax rate any way. After all the credits and other tax loopholes that have been accumulated over the decades, the effective tax rate for most corporations is well below. The tax rate for some companies is zero or below.

 

As with most new or proposed legislation nowadays, even if the tax is passed, it would likely be challenged in court. The American Constitution does not allow so-called direct taxes. The idea is that you can't levy a tax on someone that can't be imposed on others. However, thanks to the 16th Amendment, there is an exception when it comes to income taxes, which allows Congress to tax earnings. A court case would focus on whether a billionaires' tax would count as an income tax.

 

The new plan is a result of the present stumbling block between Democrats of different persuasions. Sen. Joe Manchin III, a Democrat from West Virginia, and Sen. Kyrsten Sinema, a Democrat from Arizona, have stalled any agreements, both from the size of the spending, as well the best way to pay for it. Will this tax, as well as the minimum corporate tax, ever see the light of day?

 

In the case of the corporate minimum tax there may be enough support for it within the Senate. As for a billionaire's tax, probably not.  Aside from the question of constitutionality, the current Supreme Court would also be an obstacle to interpretating the legality of the tax. The billionaire victims of the proposal, while a small group, carry enormous political weight among politicians. They would be sure to express their opposition (privately) to those that matter.

 

And finally, most Americans would probably see this kind of wealth tax as an unmistakable step toward socialism, if not Marxist. I don't think the average voter is ready to take that step quite yet.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.