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Inflationary Anti-Inflationary Act?

Will the Newly Introduced Inflationary Reduction Act Do it’s Job?
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Inflationary Anti-Inflationary Act?

Will the Newly Introduced Inflationary Reduction Act Do it's Job?

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It is still all everyone is talking about – Inflation.

We had the CPI number come out on Wednesday at 8.5% YoY, below the expectation of 8.7%. Woohoo! Prices only increase 8.5% YoY instead of 8.7% YoY…

While the market gave a huge “Hoorah!” and sent stocks up over the day, it also makes you zoom out to try to grasp how this evolves going forward.

Are we stuck in a higher for longer inflationary (and therefore – interest rate) environment? Or have we seen the peak and this is the first sign of easing?

It all depends on certain components of inflation and how they play out. This recent soft reading looks mostly due to easing commodity prices and softer demand, as the cure for high prices is… you guessed it… high prices.

But there was also a historic bill released last week with the aim of directly lowering inflation – the Inflation Reduction Act (IRA). There is a lot to unpack in this bill’s 755 pages, but we’ll keep it high level and try to relate it all back to its main objective – putting a lid on inflation.

This week, in <5 minutes, we’ll cover the Inflation Reduction Act:

  • Quick Look At Recent CPI Number 👉 Inflation Still Rampant, But Easing

  • What is the Inflation Reduction Act 👉 Overview, Slimmed-Down Version of BBB

  • Key Components Pt. 1 👉 15% Minimum Tax Rate, Buyback Tax, Carried Interest, IRS Firepower

  • Key Components Pt. 2 👉 Prescription Drug Price Reform, ACA Subsidy Extension

  • Key Components Pt. 3 👉 Energy Security and Climate Change Initiatives

  • Actual Impact on Inflation 👉 Help, Hurt, or… meh?

Let’s get started!

1. Quick Look At Recent CPI Number 👉 Inflation Still Rampant, But Easing

The CPI figure came in softer than expected, as mentioned above, and continues to be the most important piece of the puzzle when it comes to the overall path of the economy in the United States.

Since the Fed’s dual mandate includes a close eye on inflation, the market was looking for a soft figure that would give the Fed permission to ease off the gas on rate hikes (which are contractionary to the overall economy).

Many are talking of a “Powell Pivot” which would mean he would shift from emergency hikes (50-100bps) to either more moderate hikes (25bps per meeting), leveling off of rates, or even cuts in the future (which I think is definitely quite a ways out – can’t jump the gun here).

Understanding the components of CPI is much more important than some arbitrary headline percentage, so let’s break it down:

As we can see, near the end of 2020 we saw the start of goods inflation taking off while the services side saw fell as demand consumption patterns shifted over Covid. Makes perfect sense as everyone sat at home ordering extra monitors off Amazon instead of going to Disneyworld.

When it comes to food, clogged shipping channels, increased labour production costs, and higher raw material costs have caused this component (yellow bar) to accelerate.

We also are well aware of the energy crisis that has been exacerbated by the war in Russia/Ukraine, as energy proves to be an extremely volatile component in CPI (green bars in 2020 vs 2022).

However, there is a construction concept of this bar chart that is very important to understand – base rates. Since everyone is watching YoY numbers very closely, there will become a time where “the comp” (AKA last year’s number) will be a very large base, thereby making the required jump in dollar-denominated inflation absolutely massive in order to match YoY percentage gains. The point here being – it’s all about the rate of change.

While we may remain in a “higher-for-longer” period, the “Oh shit, we’re behind the curve, time to panic” vibe that the Fed has given the street seems to be very well “priced in” to what we are seeing now in the market.

Since the market hates uncertainty in terms of the rate hike path from the Fed, a clearer picture on inflation will help ease these concerns. While CPI is still high on an absolute level basis, and while one month does not make a data sample set, it does do one thing – change the narrative.

The narrative after this print was, “party on”, which sent risk assets higher, but we’re going to need another couple of months to really form a more solid narrative.

Now let’s look at how the government is trying to tackle the Inflation problem from a policy (fiscal) perspective rather than a monetary one.

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2. What is the Inflation Reduction Act (IRA) 👉 Overview, Slimmed-Down Version of BBB

The Inflation Reduction Act of 2022 was approved via the budget reconciliation process on Aug. 7, with Vice President Kamala Harris serving as a tie-breaker on the vote.

The IRA is targeted to make a down payment on deficit reduction to fight inflation, invest in domestic energy production and manufacturing, and reduce carbon emissions roughly 40% by 2030.

The bill will also allow Medicare to negotiate prescription drug prices and extend the ACA (Obamacare) program for three years through 2025 while lowering premiums for millions of Americans.

The energy production and manufacturing side of the equation will be tackled by permitting legislation reform aimed at accelerating domestic energy and transmission projects.

It also goes after the biggest corporations and ultra-wealthy in the form of taxes, while there are no new taxes on families making $400,000 or less and no new taxes on small businesses.

The IRS is also undergoing a much-needed facelift in the form of a direct cash injection which should bolster crack-downs and enforcement.

For all you Balance Sheet/Income Statement enthusiasts out there, the line-items breakdown is as follows:

Now, let’s dive into each objective.

But first, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel!

3. Key Components Pt. 1 👉 15% Minimum Tax Rate, Buyback Tax, Carried Interest, IRS Firepower

It is no secret that there is a widening income inequality gap in America. This has been widely documented. In 1965, a typical corporate CEO earned about twenty times that earned by a typical worker; by 2018, the ratio was 278:1.

The 2008 global financial crisis, the slow and uneven recovery, and the economic shock caused by the COVID-19 pandemic have deepened these trends and challenged policymakers to respond.

In 2021, the top 10% of Americans held nearly 70% of U.S. wealth, up from about 61% at the end of 1989. The share held by the next 40% fell correspondingly over that period. The bottom 50% (roughly sixty-three million families) owned about 2.5% of the wealth in 2021.

The Tax codes enforced in the IRA are attempting to take aim at this income inequality.

Creation of a 15% corporate minimum tax rate

A large mandate here is trying to tax large corporations with huge profits. This is really an easy one to go after – especially as we head towards a potential recession. It’s politically in line with everyone that large corporations should pay their fair share, as long as it doesn’t deter free enterprise from operating in the US in the future.

Corporations with at least $1 billion in profits over the last three years will have a new tax rate of 15%. This tax rate will be applied to worldwide “book” profits that corporations make public for shareholders and potential investors, instead of what they typically report to the IRS for tax purposes (after write-offs).

To me, this sounds like an extremely difficult and cumbersome process to undertake. There are many legal ways that certain corporations largely avoid paying taxes, whether it’s certain depreciation schedules, write-offs, carve-outs, etc… which is also part of why they are giving the IRS more firepower to do this properly…

IRS Firepower

The IRA would provide $80 billion in additional funding for the IRS which would result in $204 billion in additional revenue collections. (The Treasury Department points out that the real revenue impact would likely be $400 billion over a decade.) The new funding would reverse a decade of cuts to the IRS enforcement budget that have left the agency with fewer auditors than at any time since World War II.

On the one hand, overzealous bureaucracy really pisses me off. But on the other, I find comfort in knowing that the proper tools (and budget) will finally be installed to promote a more equitable ecosystem.

Private Equity Loophole on 15% Minimum Tax

However, private equity bros nearly jumped out of their boat shoes in rejoicing when they heard amendments from the Senate. The Senate approved an amendment from Sens. Thune and Sinema creating a loophole in the minimum tax for corporations owned by private equity funds.

Private equity funds are structured as partnerships rather than C corporations that are required to pay corporate income taxes. A large corporation made up of several subsidiary corporations could be subject to the minimum tax but a functionally equivalent private equity fund that owns several corporations would not be, as a result of the Thune-Sinema amendment.

This sounds like a royal mess-up to me and does not look good. Speaking of loopholes…

Carried Interest Loophole

“Carried interest” is a share of profits in a business venture and is one type of compensation paid to private equity fund managers in return for investing and managing someone else’s money.

But unlike other compensation paid for work, the fund managers claim that carried interest is capital gains and thus eligible for lower income tax rates than would normally apply to earned income.

The provision to close this loophole around “carried interest” got scrapped in the final minutes as well!

Some believe that this is part of the problem – as the US tax code treats income from wealth (which mostly goes to very well-off households) more generously than income from work.

1% Buyback Excise Tax

Stock dividends and stock buybacks are both ways that corporations transfer profits to shareholders, but only dividends are taxed under current law.

This law would see corporations pay a 1% excise tax when they purchase their own stock from shareholders, which would reduce the tax advantages for stock buybacks.

4. Key Components Pt. 2 👉 Prescription Drug Price Reform, ACA Subsidy Extension

Prescription Drug Price Reform

In addition to letting Medicare negotiate drug prices on behalf of consumers, the bill limits out-of-pocket prescription costs for Medicare beneficiaries to $2,000 per year. The cap would save roughly 1 million seniors about $1,000 each year.

And if drug companies raise prices faster than inflation, they’ll owe rebates to Medicare — presumably a deterrent to the sort of price hikes that can cripple the budgets of older Americans.

ACA Subsidy Extension

Health coverage will be more affordable for 13 million people because the Inflation Reduction Act extends enhanced Affordable Care Act (ACA) marketplace subsidies through 2025.

The average enrollee will save about $800 per year on premiums. Thanks to the ACA, the uninsured rate is at a record low, and the subsidy extension will prevent 3 million people from becoming uninsured.

5. Key Components Pt. 3 👉 Energy Security and Climate Change Initiatives

If successful (as it stands), this legislation will pour US$370 billion into energy security and climate change, supporting a wide range of industries with considerable overlap with the failed Build Back Better Bill of 2021.

Make no bones about it. This is the largest climate investment in US history.

But it also leaves a lot of question marks. This bill comes at an extremely critical time when it comes to our energy infrastructure. After what has been a drastic underinvestment in energy, the world found out overnight that they do indeed still rely on many fossil fuels for energy.

It turns out we shouldn’t have listened to a Swedish teenager when it comes to real supply and demand issues in our extremely fragile energy infrastructure. The rapid proliferation of ESG and the villainization of fossil fuels has led to drastic underinvestment in Energy as a whole, and we’re feeling the pain as exogenous geopolitical shocks exacerbated pre-existing issues.

Without getting too far down the fossil fuel conundrum, it’s clear we need an alternative – cleaner energy. But we need a lot of it and it needs to be more resilient rather than intermittent.

Regarding “energy security and climate change initiatives,” you have to aim at the former before moving on to the latter, but I digress…

The bill takes aim at solving these problems.

At the core of the legislation are tax credits for companies that build wind and solar power as well as a slew of other clean energy technologies. These credits, which last for ten years, will catalyze the creation of a decarbonized energy system and serve as the driving force behind the bill’s emissions reduction.

Beyond that, a range of industries will be nudged to decarbonize. Airlines will get credit for buying lower-carbon fuel. Industrial firms will receive financial incentives to capture and store carbon dioxide in their production process.

The legislation gives the Department of Energy the authority to loan private companies up to $250 billion to advance clean energy programs. Tesla received a loan from that same program a decade ago, helping it expand its manufacturing.

The next clean technology giant could benefit from a similar loan, if not other provisions in the Inflation Reduction Act.

There are also incentives on the end consumer side whether it’s home renovations to make them more energy efficient or overall lower costs of renewable power. But a little bit more of a direct one is the $7,500/vehicle tax credit being applied to electric cars.

Great! you might be thinking. But not so fast… the bill requires that new electric vehicles meet stringent sourcing requirements for critical materials, the components of the battery, and final assembly to qualify for the tax credits.

While some automakers, like Tesla and GM, have well-developed domestic supply chains, no electric vehicle manufacturer currently meets all the bill’s requirements.

Right now, China dominates the global supply chain for materials and lithium-ion batteries used in electric vehicles. This is no accident. Since the early 2000s, Chinese policymakers have adopted aggressive policies that have supported advanced battery technologies, including investments in mines, materials processing, and manufacturing.

An entire onshoring of all of these processes would need to be done in order for the tax credit to stand as is. Yes, there could be exemptions, but there seems to be a hidden agenda here that would involve HUGE CAPEX expenditures to onshore battery material production.

6. Actual Impact on Inflation 👉 Help, Hurt, or… meh?

Let’s face it, the FOMC meetings have a FAR greater impact on inflation than this bill does, but the amount of capital being directed towards these initiatives could have an impact on overall inflation over the long term.

The shortest-term impact on inflation that is being introduced in this bill will be the impact on healthcare costs. This bill’s targeted approach to limit out-of-pocket prescription costs and better monitor drug prices will alleviate pressure on the average consumer.

While this is a monumental bill from the clean energy side, the impact of build-out capacity will take a while to recognize. Providing ITC credits incentivizes producers to build out more capacity, but the dollar translation is nowhere near one-to-one when it comes to passing on cost savings to the end consumer. We know we have not built out renewable capacities to where they need to be, so this bill is a step in the right direction, but not a saving grace.

And while the EV credit takes steps in the right direction to curb climate change, it doesn’t do anything to lower the price of mayonnaise:

Conclusion: Overall impact on inflation will be MEH?

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

P.S. Have you checked our new CARBON and CRYPTO newsletters? Subscribe for free!

What else we Grittin’ On?

SPENDING. According to BofA, credit card spending among US consumers is slowing down. Consumers are feeling the pressure of rising prices.

ELON. Elon Musk sold $6.9 billion worth of shares recently. He'll need the cash if the Twitter deal actually happens.

ECONOMY. US productivity fell for the second straight quarter. Meanwhile, labor costs surged.

UNSOLICITED. Software developer AppLovin made an unsolicited proposal to buy Unity for $20 billion. Unity has already agreed to buy AppLovin rival IronSource.

HOUSING. US home inventories are rising at a record pace. They remain historically low, however.

Sources:
https://www.forbes.com/advisor/personal-finance/inflation-reduction-act/
https://www.democrats.senate.gov/imo/media/doc/inflation_reduction_act_one_page_summary.pdf
https://www.cfr.org/backgrounder/us-inequality-debate
https://itep.org/what-tax-provisions-are-in-the-senate-passed-inflation-reduction-act

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Disclaimer:The publisher does not guarantee the accuracy or completeness of the information provided in this page.  All statements and expressions herein are the sole opinion of the author or paid advertiser.

Grit Capital Corporation is a publisher of financial information, not an investment advisor.  We do not provide personalized or individualized investment advice or information that is tailored to the needs of any particular recipient.  

THE INFORMATION CONTAINED ON THIS WEBSITE IS NOT AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND DOES NOT PURPORT TO BE AND DOES NOT EXPRESS ANY OPINION AS TO THE PRICE AT WHICH THE SECURITIES OF ANY COMPANY MAY TRADE AT ANY TIME.  THE INFORMATION AND OPINIONS PROVIDED HEREIN SHOULD NOT BE TAKEN AS SPECIFIC ADVICE ON THE MERITS OF ANY INVESTMENT DECISION.  INVESTORS SHOULD MAKE THEIR OWN INVESTIGATION AND DECISIONS REGARDING THE PROSPECTS OF ANY COMPANY DISCUSSED HEREIN BASED ON SUCH INVESTORS’ OWN REVIEW OF PUBLICLY AVAILABLE INFORMATION AND SHOULD NOT RELY ON THE INFORMATION CONTAINED HEREIN.

No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.  

Any projections, market outlooks or estimates herein are forward looking statements and are inherently unreliable.  They are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.  Other events that were not taken into account may occur and may significantly affect the returns or performance of the securities discussed herein.  The information provided herein is based on matters as they exist as of the date of preparation and not as of any future date, and the publisher undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional material.

The publisher, its affiliates, and clients of the a publisher or its affiliates may currently have long or short positions in the securities of the companies mentioned herein, or may have such a position in the future (and therefore may profit from fluctuations in the trading price of the securities).  To the extent such persons do have such positions, there is no guarantee that such persons will maintain such positions.

Neither the publisher nor any of its affiliates accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein.

By using the Site or any affiliated social media account, you are indicating your consent and agreement to this disclaimer and our terms of use. Unauthorized reproduction of this newsletter or its contents by photocopy, facsimile or any other means is illegal and punishable by law.

For Full Terms of Use Click HERE. For the Privacy Policy Click HERE.

Gritcapital.substack.com (“Grit”) is a website owned and operated by Substack. Grit is paid fees by the companies that make investment offerings on this website. Be aware that payment of these fees may put Grit in a conflict of interest with the investor. By accessing this website or any page thereof, you agree to be bound by the Terms of Use and Privacy Policy, in effect at the time you access this website or any page thereof. The Terms of Use and Privacy Policy may be amended from time to time. Nothing on this website shall constitute an offer to sell, or a solicitation of an offer to buy or subscribe for, any securities to any person in any jurisdiction where such an offer or solicitation is against the law or to anyone to whom it is unlawful to make such offer or solicitation. Grit is not an underwriter, broker-dealer, Title III crowdfunding portal or a valuation service and does not engage in any activities requiring any such registration. Grit does not provide advice on investments or structure transactions. Offerings made under Regulation A under the U.S. Securities Act of 1933, as amended (the “Securities Act”) are available to U.S. investors who are “accredited investors” as defined by Rule 501 of Regulation D under the Securities Act well as non-accredited investors, who are subject to certain investment limitations as set forth in Regulation A under the Securities Act. In order to invest in Regulation A offerings, investors may be asked to fill out a certification and provide necessary documentation as proof of your income and/or net worth to verify that you are qualified to invest in offerings posted on this website. All securities listed on this site are being offered by, and all information included on this site is the responsibility of, the applicable issuer of such securities. Grit does not verify the adequacy, accuracy or completeness of any information. Neither Grit nor any of its officers, directors, agents and employees makes any warranty, express or implied, of any kind whatsoever related to the adequacy, accuracy, valuations of securities or completeness of any information on this site or the use of information on this site. Neither Grit nor any of its directors, officers, employees, representatives, affiliates or agents shall have any liability whatsoever arising from any error or incompleteness of fact, or lack of care in the preparation of, any of the materials posted on this website. Investing in securities, especially those issued by start-up companies, involves substantial risk. investors should be able to bear the loss of their entire investment and should make their own determination of whether or not to make any investment based on their own independent evaluation and analysis.