U.S. Fiscal policy issues on the horizon

U.S. Fiscal policy issues on the horizon

Within the next month, several key components of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, including the enhanced unemployment compensation program and the Paycheck Protection Program (PPP), are set to expire. With unemployment still sky-high and economic activity way below its pre-pandemic level, Congress and the Trump Administration in all likelihood will agree to last-minute legislation that will extend these provisions, some in a modified form. Congress nearly always responds to absolute time deadlines, especially when failing to do so harms the reputations of its members. We emphasize the high degree of uncertainty in light of the rapidly evolving environments in economic and health conditions and politics.

This near-term legislation is expected to include extending the enhanced unemployment compensation, with some modification to the $600 additional weekly benefit, likely with a smaller weekly payment augmented with a back-to-work incentive. In addition, this near-term legislation is likely to include one-time new payments to individuals. The Democratic-controlled House passed a $3.5 trillion fiscal package in May (the Heroes Act) that proposes another round of $1,200 payments to individuals ($2,400 for joint taxpayers), and President Trump and Treasury Secretary Mnuchin have indicated that the Administration also favors additional income payments, but have not specified an amount. Also, in light of the large financing gaps for state and local governments, this near-term legislation will likely include grants to state and local governments.

While both parties have clearly indicated more infrastructure spending, they disagree on basic infrastructure issues and it seems unlikely it will be included in this near-term legislation. If so, infrastructure spending would next be considered when the Fixing America's Surface Transportation (FAST) Act, which funds the Highway Trust Fund, expires in September.

Enhanced and expanded unemployment benefits

The CARES Act, enacted March 27, enhanced standard unemployment insurance (UI) in several key ways: it extended UI from 26 weeks to 39 weeks and provided an additional $600 per week until July 25-26, and made unemployment benefits available to self-employed individuals and independent contractors through year-end. The CARES Act also provided income support, distributing payments of $1,200 per person with incomes up to $75,000 ($2,400 for joint taxpayers with incomes up to $150,000), phasing out entirely at $99,000 for individuals (and $198,000 for joint taxpayers), and $500 to qualified taxpayers for each child.

Chart 1 shows the Bureau of Economic Analysis’ estimates of income from wages and salaries, unemployment compensation, and the income support payments. Wages and salaries fell sharply in March-April 2020 but that decline was more than offset by unemployment compensation and direct income support payments. Most of the government income support payments were distributed in April, while the enhanced unemployment compensation including the $600 per week supplement were paid in April and even more in May. The BEA estimates that the total unemployment insurance payments to households in April and May were $144 billion. Consequently, disposable income that includes government transfers has risen sharply, despite the historic rise in unemployment and sharp fall in wages and salaries.

Chart 1: Wages and salaries, unemployment insurance benefits and income

support payments to individuals

Source: Bureau of Economic Analysis and Berenberg Capital Markets

Congress and the Trump Administration must consider whether to extend the enhanced unemployment insurance before it expires. Everybody agrees that it was the proper role of government to provide income support and enhanced unemployment compensation to people impaired by the shutdowns and the pandemic, including furloughed workers who continued to receive health benefits and pension coverage by employers but were not paid wages. These considerations are still appropriate since through June only about one-third of the net jobs lost have been regained and the unemployment rate is 11.1%.

However, the issue of whether to extend the additional $600 per week in unemployment compensation will be at the center of the political compromise. The $600 per week enhancement was designed to close the gap between the $387 average state weekly unemployment benefit and the pre-pandemic average weekly earnings of $981. However, for many who have been unemployed, the total government unemployment compensation, including the $600, exceeded what they had been earning in wages when they were working. Concerns that this may distort labor markets and deter people’s desire to go back to work, as well as the impact on government finances, will play a key role in the negotiations.

Amid such high unemployment and labor market churn related to the pandemic, shutdowns and partial but uneven reopening, it is too early to assess the effects on labor markets of the generous unemployment compensation. The near-term issue is insufficient demand for labor. While nonfarm payrolls increased more than expected in May (+2.7 million) and June (+4.8 million), the latest Job Openings and Labor Turnover Survey (JOLTS) data show that, although job openings increased in May, they remained depressed at 5.4 million, well below the 7 million job openings in February and were only a fraction of the 21 million unemployed persons that month (Chart 2). There is anecdotal evidence that some firms are having a difficult time finding suitable labor to rehire, but to date there are no hard data confirming insufficient labor supply stemming from the government’s income support programs. However, as the recovery progresses and continues to lift labor demand, the generous unemployment benefit would likely pose an undesired constraint on the supply of labor.

Chart 2:

The additional $600 per week unemployment compensation benefit will end on July 25 for all states except for New York and on July 26 for New York. In legislation that has passed the Democratic House(the Heroes Act), the $600 enhanced supplemental benefit is extended until next January. Senate Democrats have proposed reducing the enhanced unemployment benefit as a state’s unemployment rate declines. Republicans have proposed a back-to-work bonus that provides additional weekly payments for persons who return to work. The Administration has not yet proposed a formal recommendation on this issue.

We believe the most likely bipartisan compromise by month-end will be an extension of the enhanced unemployment compensation by less than $600/week until next January, closer to $400, combined with a one-time “back–to-work” incentive payment to people who take jobs.

Direct income support payments to individuals

An estimated $300 billion in payments to individuals provided by the CARES Act was important income support that offset losses in wages and salaries. A daily tracker of consumer spending indicates that the upturn in spending occurred when the bulk of the government checks was distributed in mid-April (Chart 3).

Chart 3: Consumer spending tracker

*Baseline is Jan. 4-31, 2020. Source: Opportunity Insights

The House’s Heroes Act proposes a second round of direct payments of $1,200 to individuals and $2,400 to married couples, with the same income thresholds as the CARES Act, and an additional $1,200 for tax filers for each qualified dependent (up to a maximum of three). The total cost of such an initiative is estimated by the Joint Committee on Taxation (JCT) to be $413 billion. The Administration has indicated that it favors another round of direct payments, but has not specified an amount.

We anticipate Congress and the Trump Administration will agree to another round of direct payments to households. However, the magnitudes of the payments are uncertain and there is a possibility that the income scales of recipients eligible to receive them may be reduced modestly.

Transfers to state and local governments

Even with the $150 billion in aid the CARES Act provided to state and local governments, they still face huge financing gaps generated by the deep economic contraction and the COVID-19 pandemic. Some were in bad financial shape prior to the pandemic because their budgets were squeezed by high and rising outlays for public pensions and Medicaid. Faced with the requirement of balancing their operating budgets, many had begun to trim some basic services.

The impact of the pandemic and government shutdowns on states’ finances have been devastating. States’ tax receipts rely most heavily on income (individual and corporate) taxes and sales taxes, while municipalities rely most heavily on property taxes. Plummeting wage income and consumption hit State tax receipts at the same time demand for services – particularly health and social services – rose. State and local governments have already cut 1.5m jobs since February (Chart 4). Many of those have been in education services, but they have been widespread among other government agencies. States currently facing dramatic increases in COVID-19, including California, Texas, Florida and Arizona, face significant further financial shortfalls with no chance of near-term repair. The National Conference of State Legislators (NCSL) reports that tax receipt projections for Fiscal Year 2021 have been revised down by anywhere between 5% in some states to over 20% in some states, including California.

Chart 4:

The House Democrats’ Heroes Act would provide nearly $1 trillion in Federal grants to state, local, territorial and tribal governments. The Administration says that further Federal aid is appropriate but has not proposed a specific amount. In light of the immediacy of the issue, and the expected further negative impacts of the recent spike in COVID-19 incidence in some key Western and Southern states, it is likely the near-term legislation will include a sizable Federal grant to state and local governments. The amount may be close to the $500 billion recommended by the National Governors Association, but that is uncertain.

Paycheck Protection Program

Since the Paycheck Protection Program (PPP) was instituted as part of the CARES Act, its deadline has been extended several times, the latest to August 8. The PPP provides loans to small businesses through the Small Business Administration (SBA) and forgives the amount of principal from eligible loans equal to the sum of expenses for payroll, and existing interest payments on mortgages, rent payments, leases, and utility service agreements if small businesses retain employees. The terms of the program have been amended to lower the percent of payroll costs needed for full loan forgiveness to 60% from 75%, and to extend the time to use the loan (from date of disbursement) from 8 weeks to 24 weeks.

Despite earlier delays in PPP operations and some anecdotal evidence that some businesses received grants inconsistent with the intent of the program, overall the PPP has been a critically important vehicle for providing financial support to small businesses. Of the $659 billion that has been authorized for the PPP program, roughly $134 billion is remaining. In testimony before the Congressional House Financial Services Committee, Treasury Security Mnuchin indicated a willingness to work with Congress to repurpose the unused amount to businesses such as restaurants and hotels that have been especially hard-hit. We expect the deadline for applying to this program to be extended beyond August 8 if funds remain unused. If the $134 billion is used by the end of the month, the Congress will likely appropriate more funds to the program.

Fed lending facilities

The CARES Act allocated $454 billion to the Treasury to fund Federal Reserve direct lending to businesses. So far, the Treasury has allocated $200 billion to these lending facilities, and the Fed has made them operational only recently. The Treasury still has $254 billion remaining from the CARES Act to expand or create new Fed lending facilities, and the Fed may leverage this amount of capital into several trillion dollars of lending. Accordingly, at this point there is no need for the Congress to add to this capital allocation to the Treasury on behalf of the Fed.

Infrastructure spending

Both Democrats and the Trump Administration favor increased spending for infrastructure, but the prospects of enacting legislation is uncertain, and very unlikely to be included in the near-term package. House Democrats have introduced a $1.5 trillion infrastructure bill to repair roads and bridges, expand broadband access in rural areas, fund clean energy projects and fund public housing, while the Administration is said to be working on a $1 trillion infrastructure package for roads and bridges, 5G wireless infrastructure and rural broadband. However, there are likely to be large differences in how the infrastructure funding is allocated and how the projects would be administrated.

The FAST Act, which authorizes funding for federal transit, rail, and highway programs, is scheduled to expire on September 30 and will require legislation to be extended. While this would be a logical catalyst for Congress to consider a larger infrastructure package, it likely will be scuttled by election year politics.

Mickey Levy, mickey.levy@berenberg-us.com

Roiana Reid, roiana.reid@berenberg-us.com

Member FINRA & SIPC
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