Podcast Summary: "What the Tax Debate Could Mean for Markets"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: What the Tax Debate Could Mean for Markets
• Release Date: May 14, 2025

Introduction

In the May 14, 2025 episode of Thoughts on the Market, hosted by Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy at Morgan Stanley, alongside Ariana Salvatore, Public Policy Strategist, the discussion centers on Congress's deliberations regarding tax and fiscal spending. The conversation delves into the potential ramifications of the current tax debate on various market sectors, investor expectations, and the broader economic landscape.

Congressional Tax and Fiscal Spending Deliberations

Michael Zezas opens the discussion by addressing the intense focus clients have on the ongoing tax and spending plans that Congress is pursuing. Ariana Salvatore elaborates on why this fiscal package is capturing significant attention from investors across different asset classes.

"Clients have reasons to focus on this tax policy bill across equities, fixed income, and for macroeconomic impacts."
— Ariana Salvatore, 00:36

Salvatore highlights the expiration of the 2017 Tax Cuts and Jobs Act (TCJA) at the end of the year, positioning the current bill as an opportunity for Congress to extend these tax cuts and potentially introduce additional ones proposed by President Trump during his campaign. She emphasizes the sector-specific impacts of the legislation and underscores the importance of deficit considerations on economic outcomes and bond yields.

Investor Expectations and Market Implications

Zezas explores the multifaceted nature of the fiscal policy package and its varied interpretations among investors. He notes that the package allows for both optimistic and pessimistic projections, depending on the focus—whether on deficit expansion or economic growth benefits.

"We're not going to get policy that really justifies either your highest hopes or your greatest fears here."
— Michael Zezas, 02:20

Zezas posits that the likely outcome lies somewhere in the middle, suggesting that the policy may not significantly sway the markets toward extreme optimism or fear. He discusses scenarios where tax cuts could lead to deficit expansion, potentially increasing Treasury yields due to a higher supply of bonds needed to finance the cut. Conversely, tax cuts could stimulate economic growth, benefiting corporate earnings and equity markets.

Deficit Impact and Fiscal Outlook

Transitioning the conversation, Salvatore identifies key areas of disagreement within Congress that could influence the final structure of the tax bill. The cap on state and local tax (SALT) deductions emerges as a significant sticking point, along with debates over spending cuts to programs like Medicaid and SNAP (food stamps).

"We think where that lands is effectively at a $90 billion or so deficit increase from just the tax policy changes next year."
— Ariana Salvatore, 05:33

Salvatore estimates that the tax policy changes alone could result in a $90 billion increase in the deficit, excluding tariff revenue, bringing the total to approximately $130 billion. When accounting for scheduled increases in outlays, the overall deficit could rise by about $310 billion.

Zezas contextualizes these figures by contrasting them with Congressional Budget Office (CBO) projections, which often span a decade. He advises investors to focus on the short-term impacts, as long-term policies remain highly uncertain and subject to future legislative changes.

"These numbers might seem a lot smaller than some of what's been reported in the press... policy uncertainty beyond a year is substantially higher than even the very high policy uncertainty we're experiencing right now."
— Michael Zezas, 06:55

Key Policy Debates: SALT Cap and Spending Cuts

A central theme in the discussion is the SALT cap, initially set in the 2017 TCJA, which limits the state and local tax deductions that individuals can claim. Republicans are divided on this issue, with some advocating for a modest increase or income thresholds, while the SALT caucus seeks a full repeal or significant modifications.

"Republicans generally are okay with making a modification to that cap... but the SALT caucus... pushing for a full repeal or something bigger..."
— Ariana Salvatore, 05:33

Additionally, there is contention within the Republican party regarding the preservation of the Inflation Reduction Act and whether to impose spending cuts on social programs. These internal divisions create continuous tension points that Congress must navigate to finalize the fiscal package.

Timing, Uncertainty, and Legislative Outlook

The timing of the tax bill's resolution remains a critical factor. Salvatore outlines the expected timelines, noting that the reconciliation bill aimed at addressing the expiring debt ceiling is scheduled to culminate around August or September, contingent on the exhaustion of extraordinary measures.

"The reconciliation bill is supposed to address the expiring debt ceiling... our estimate is that it's somewhere around August or September."
— Ariana Salvatore, 08:25

Key milestones include Treasury projections for the "X date"—the point at which U.S. finances could face default—and legislative markups where the details of unresolved disputes, such as the SALT cap, will be scrutinized. Salvatore anticipates that the House is tentatively pushing for a resolution by Memorial Day, which is six legislative days away at the time of the discussion.

Zezas emphasizes the evolving nature of the legislative process and the need for investors to stay attuned to daily developments that could influence fiscal policy outcomes.

"We're going to have to keep checking those regularly as we get new bits of information coming out of Congress on probably a daily basis at this point."
— Michael Zezas, 09:17

Conclusions and Investor Recommendations

Both Zezas and Salvatore concur that while the current fiscal policy discussions introduce elements of expansion, the overall stance on U.S. fiscal policy is expected to remain largely unchanged. They caution investors to consider the short-term impacts of the tax debate, given the high level of uncertainty surrounding long-term policy directions.

Zezas concludes by reinforcing the importance of breaking down headline figures within their appropriate context and focusing on the immediate fiscal implications that are more predictable compared to the volatile policy landscape beyond the upcoming fiscal year.

"The context matters a lot here. We have been encouraging investors to really look through the headlines, really break down the context and really focus on these short term impacts because those are the most reliable impacts and the ones to really anchor to..."
— Michael Zezas, 06:55

Final Thoughts

The episode provides a comprehensive analysis of the ongoing tax debate in Congress, highlighting its potential impacts on different market segments and the broader economy. With key issues like the SALT cap and spending cuts at the forefront, the discussions underscore the complexity and uncertainty inherent in the legislative process. Investors are advised to focus on short-term fiscal impacts while remaining vigilant of evolving policy developments.

Notable Quotes:

1. "Clients have reasons to focus on this tax policy bill across equities, fixed income, and for macroeconomic impacts."
   — Ariana Salvatore, 00:36

2. "We're not going to get policy that really justifies either your highest hopes or your greatest fears here."
   — Michael Zezas, 02:20

3. "We think where that lands is effectively at a $90 billion or so deficit increase from just the tax policy changes next year."
   — Ariana Salvatore, 05:33

4. "These numbers might seem a lot smaller than some of what's been reported in the press... policy uncertainty beyond a year is substantially higher than even the very high policy uncertainty we're experiencing right now."
   — Michael Zezas, 06:55

5. "Republicans generally are okay with making a modification to that cap... but the SALT caucus... pushing for a full repeal or something bigger..."
   — Ariana Salvatore, 05:33

6. "The reconciliation bill is supposed to address the expiring debt ceiling... our estimate is that it's somewhere around August or September."
   — Ariana Salvatore, 08:25

7. "We're going to have to keep checking those regularly as we get new bits of information coming out of Congress on probably a daily basis at this point."
   — Michael Zezas, 09:17

8. "The context matters a lot here. We have been encouraging investors to really look through the headlines, really break down the context and really focus on these short term impacts because those are the most reliable impacts and the ones to really anchor to..."
   — Michael Zezas, 06:55