Fixed income had a strong second quarter, with most sectors shaking off the volatility of Q1 to turn positive for the year.
Quality still lead the pack, with treasuries and agencies outperforming followed by investment grade credit and municipal bonds. High yield had an impressive Q2, but it was not enough to offset a dismal start to the year; the high yield index ended down 1.38% YTD. Interest rates look to remain low, with Jerome Powell stating in June that the Fed was “not even thinking about thinking about raising rates.”
Review
The table below summarizes the returns of a few major fixed income indices
The strong outperformance of treasuries during the pandemic has AAA-rated tax-free Munis yielding more than UST. The chart below shows the ratio between a 10 year UST and a AAA-rated tax-free Muni. Ratios are relatively attractive for Munis since they yield about 135% of a UST in the 10 year part of the curve.
Taxes Are Going Higher: Income Inequality Tax
The current pandemic has put stress on the finances of state and local governments due primarily to a reduction of tax revenues received. Municipalities which depend on sales tax revenues and income tax revenues are looking for ways to balance their budgets. There has also been pockets of civil unrest and concerns about social-justice issues around the country. This has led some municipalities to consider Bernie Sander’s “Income Inequality Tax Plan” as a way to increase their tax revenues. This plan seeks to impose an additional tax on corporations, both public and private, with annual revenues of more than $100 million which have large pay gaps between their CEO and median worker pay. His plan would cause these corporations to have the following tax increases depending on their compensation ratio:
CEO pay between 50 and 100 times median worker pay: +0.5% tax increase
CEO pay between 100 and 200 times median worker pay: +1.0% tax increase
CEO pay between 200 and 300 times median worker pay: +2.0% tax increase
CEO pay between 300 and 400 times median worker pay: +3.0% tax increase
CEO pay between 400 and 500 times median worker pay: +4.0% tax increase
CEO pay more than 500 times median worker pay: +5.0% tax increase
The Seattle City Council is looking at different proposals to tax companies based on the size of their payrolls. This would affect about 800 companies in the area with payrolls exceeding $7 million dollars annually.
Citizens in San Francisco will be voting on the “Overpaid Executive Tax” which would impose higher taxes on companies where the highest paid executive makes more than 100 times the median worker pay.
Taxes Are Going Higher: Biden Tax Plan
According to the Tax Foundation Biden has the following tax plan:
Increases top individual rate from 37.0% to 39.6%
Taxes capital gains as ordinary income and eliminates step-up in basis
Caps itemized deductions to 28% of value which limits itemized deductions for those in higher brackets
Increases corporate income tax rate from 21% to 28%
Creates a minimum tax on corporations earning $100 million or more
Increases the Global Intangible Low Tax Income from 10.5% to 21.0%
Cities Delay Infrastructure Projects Due to Budget Shortfalls
A Recent survey released on 6/23/2020 conducted by the National League of Cities from over 1,100 cities found that 74.0% of them have already begun making cuts to budgets in response to revenue losses due to COVID-19. The survey also found that 65.0% of cities are either delaying or canceling capital projects. This creates a headwind for the economy and helps to explain why both Congress and the President are looking for ways to increase funding for infrastructure to help stimulate the economy and create jobs.
Four Steps To Reduce The Harm Of Fiscal Distress For States
Research by Pew Charitable Trusts suggests the following policy tools to help them be prepared for periods of fiscal stress:
Conduct Budget Stress Tests
Build Reserves or a “rainy day fund” during good years
Improve Flexibility and Responsiveness by Having Contingency Plans for Difficult Time Periods
Avoid Unsustainable Budgeting in Good Years
Conclusion
The Fed, Congress, and the President have all said or shown they are willing to do “whatever it takes” to get the economy going again. The Fed has expanded it’s balance sheet from $3.8 trillion in September 2019 to $7.1 trillion in June 2020. Congress has passed about $2.0 trillion in relief packages to help mitigate the effects of the covid-19 pandemic. There are also a variety of additional spending bills pending for infra-structure spending, aid to States and municipal entities, and other programs. This additional spending combined with the $1 trillion deficit the U.S. was already running will require additional tax revenues in the future. We feel it is reasonable to expect taxes to increase in the future, and if there is a change in administrations it becomes extremely likely.