Markets commentary – special edition

A summary of the recently passed American Recovery and Reinvestment Act and its investment impact

David Joy — Chief Market Strategist, RiverSource Investments

Feb. 17, 2009

After reaching agreement on a compromise economic stimulus package, Congress sent the legislation to President Obama who has now signed the American Recovery and Reinvestment Act into law.

The American Recovery and Reinvestment Act has a total price tag of $787 billion. This is less than the measures originally approved by both the House and the Senate. The total dollar amount is the equivalent of 5.5% of gross domestic product (GDP), although its impact on the economy may be less and will be spread over several years. The Congressional Budget Office (CBO) estimates that the greatest impact will be felt in fiscal year 2009, which ends on Sept. 30, 2009, followed by a smaller but still sizeable impact in fiscal 2010 and diminishing thereafter. Although it is estimated to be effective in accomplishing its intended purpose of stimulating the economy in the short run, the CBO projects that, because the bill is financed by an increase in public debt, it will ultimately reduce economic activity in the long run.

In general, the bill can be categorized into three main parts:

1. Direct payments to individuals
2. Reductions in federal taxes
3. Purchases of goods and services

A summary of the major and more notable components of each part follows.

Direct payments to individuals:

• $41 billion to extend through December, 2009, the extended unemployment benefits program that was scheduled to begin phase-out in March; increases jobless benefits by $25 per week; includes a temporary suspension of taxation of certain unemployment benefits
• $14 billion in special one-time payments to recipients of Social Security, SSI, and disabled veterans

Reductions in federal taxes

Individuals:

• $116 billion for a refundable tax credit of up to $400 per worker ($800 filing jointly), phasing out beginning at $75,000 of income ($150,000 for joint filers)
• $15 billion expansion of the Child Tax Credit
• $70 billion for a one-year extension of the Alternative Minimum Tax patch
• $14 billion partially refundable $2,500 higher education tax credit
• $6.6 billion for an enhanced tax credit of $8,000 for first-time home buyers
• $5 billion for extended bonus depreciation and increased small business expensing for capital expenditures in 2009
• $20 billion in tax incentives for renewable energy and energy efficiency, including cost of renewable energy facilities, energy efficient home upgrades, purchase of plug-in hybrid vehicles

State and local governments:

• $22 billion for new bond program for school construction, rehabilitation and repair, and private activity purposes

Purchase of goods and services:

• $87 billion in matching Medicaid payments
• $30 billion for power grid improvements, advanced battery technology, and state and local government energy efficiency improvements
• $15 billion for scientific research
• $7 billion for broadband services to underserved areas
• $19 billion for improvements to healthcare information technology
• $25 billion Cobra subsidy for nine months
• $54 billion State Fiscal Stabilization Fund for schools and public safety
• $13 billion for Title I education grants
• $12.2 billion for IDEA education grants
• $29 billion for road and bridge construction
• $16.4 billion for mass transit
• $18 billion for clean water and flood control

Investment impact

One of the bill's investment impacts is the expansion of the number of private purpose municipal bonds that qualify for the alternative minimum tax exemption. This applies for bonds issued in 2009 and 2010. The bill also expands the definition of industrial development bonds that qualify for tax exemption.

A number of industries and individual companies will also benefit from the spending and tax provisions in the bill. These would include companies in the alternative energy space, medical technology software, biotechnology, construction and other infrastructure-related industries.

The most striking aspect of the bill is its sheer size. It represents the largest single-year increase in domestic spending in 60 years. Its impact on the budget deficit will be enormous. Before the bill is even signed into law, the fiscal 2009 deficit is estimated to total $1.2 trillion or 8.3% of GDP. It may be recalled that the previous record occurred in 1983, during the Reagan administration, at 6% of GDP and was met with outrage at the time. During the Great Depression the deficit peaked at 5.9% of GDP in 1934. During World War II it peaked at 30.4% in 1943. If the full spending impact of the bill occurs in fiscal 2009, the fiscal 2009 deficit will expand to approximately $2.0 trillion, or 13.5% of GDP, the largest since 1945. The CBO estimates that the majority of the deficit impact will actually be spread out over three years, through fiscal 2011. Regardless, this must be financed with debt. The potential implications for inflation, interest rates and the dollar are all of concern.

But this legislation is not about the longer term. It is about stimulating the economy as quickly as possible. In that regard, this bill has many critics. They argue that the stimulative aspect of the package would be enhanced with a higher percentage of tax cuts. Others point out that once in place, spending levels are rarely rolled back. As a result, they say, this bill will mean a permanent, sharply higher base level of spending for the federal budget, making the true cost of the bill far higher than its $787 billion nominal price tag.

The CBO has calculated the bill's incremental impact on the economy. They estimate the low-/high-end estimates for the remainder of fiscal 2009 through fiscal 2011 to be:

		2009	2010	2011
Real GDP	Low-end impact	1.4%	1.1%	0.4%
	High-end impact	3.8%	3.3%	1.3%
Unemployment rate	Baseline	9.0%	8.7%	7.5%
	Low-end impact	8.5%	8.1%	7.2%
	High-end impact	7.7%	6.8%	6.5%

Another interesting section of the bill is the final provision, which while not surprising, is a little ironic in that it represents an increase in the statutory debt limit of the federal government of $787 billion, from $11.315 trillion to $12.102 trillion.

Whether this bill represents the biggest bang for the buck possible is open to debate, but even the low-end estimates by the CBO of its impact on GDP and employment suggest a meaningful near-term impact. In all probability, the economy would eventually recover on its own without the help of this program. But this program will certainly accelerate the process and buy some insurance against the chance that it would not. Only time will tell whether the stimulus package accomplishes everything we all hope it will and what the long-term costs may be, but we remain cautiously optimistic that the package will help expedite the recovery efforts and ultimately lead the U.S. economy back to sounder footing.