China Merchants Securities: The tax reduction bill will still have a positive boost on the US stock market in the next two years

According to the Zhitong Finance APP, China Merchants Securities released a research report stating that the U.S. deficit rate will be around 7% in the next two years, significantly higher than in the past two years. Currently, the performance of U.S. stocks has already priced in the positive factors of fiscal policy. In addition, AI capital expenditure is still expanding, and the logic of stablecoins will provide liquidity support for U.S. stocks. Even if the central rate of U.S. Treasury yields does not decline further, there is still upward space for U.S. stock valuations. Therefore, China Merchants Securities remains bullish on U.S. stocks ahead of the mid-term elections next year. Returning to the present, short-term adjustments may occur due to a weakening inventory cycle, escalating tariff frictions, and rising inflation, but adjustments present good opportunities for increased allocation.

The main points of China Merchants Securities are as follows:

On July 3 local time, the U.S. House of Representatives passed the "Big Beautiful Bill (OBBBA)" with 218 votes in favor and 214 votes against, and there were no modifications to the Senate version. On July 4, U.S. President Trump officially signed the bill.

What are the main contents and changes of OBBBA?

1) An increase of $3.4 trillion in the basic deficit and $0.7 trillion in interest expenses over 10 years. OBBBA stipulates a net increase of $3.4 trillion in the basic deficit over the next 10 years, including $4.5 trillion in tax cuts, $1.4 trillion in spending cuts, and $0.3 trillion in increased spending, plus $0.7 trillion in interest expenses, resulting in a total deficit of $4.1 trillion and an increase in the debt ceiling of $5 trillion. This is an increase of $1 trillion compared to the House version (which had a total deficit of $3 trillion and a debt ceiling of $4 trillion).

2) The fiscal deficit rate may be around 7% in the next three years. Although the Senate version significantly increased the net deficit after 2030 compared to the House version, the main fiscal expenditures still occur in 2026-2028. According to CBO estimates, OBBBA will bring a net increase in the deficit of $1.6 trillion during 2026-2028, accounting for about 50% of the 10-year coordinated bill, corresponding to a fiscal deficit rate of around 7% during 2026-2028 (significantly higher than in 2024-2025). This is because the main increases in spending (military and immigration spending) occur in 2026-2028, while the main reductions in spending (medical subsidies and food stamp subsidies) are reflected after 2029.

3) In terms of tax cuts, first, important provisions are made permanent. For individual income tax, the personal income tax from the 2017 TCJA is made permanent, along with the estate tax exemption and child tax credit; for corporate tax, the corporate income tax is not further reduced from the 21% base, but the four major deductions—research and development expenses, net interest, additional depreciation, and qualified business income (QBI)—are made permanent, and the tax incentives for impoverished communities, namely the Qualified Opportunity Zone (QOZ) program, are also made permanent. Second, special provisions are only applicable to Trump's term (2025-2028). For individual income tax, the small tax, overtime tax, and auto loan interest tax are eliminated, and the SALT deduction cap will increase from $10,000 to $40,000 starting in 2025, increasing by 1% each year until 2029, and then reverting to $10,000 in 2030; for corporate tax, a 100% expensing tax incentive is provided for eligible real estate structures (factories, warehouses, etc.), but construction must start between January 19, 2025, and January 19, 2029, and be put into use before December 31, 2030. Third, some tax incentives are abolished, including the termination of Biden's "Green New Deal" related expenditures, cancellation of certain social welfare program expenditures, and the abolition of personal and dependent tax exemptions 4) The reduction in spending mainly reflects in medical subsidies, clean energy subsidies, and food voucher programs, with reductions of $1.074 trillion, $543 billion, and $114 billion respectively over the next 10 years, while military, homeland security, justice, and the Homeland Security Committee will receive an increase in the deficit of $288 billion over the next 10 years, mainly for improving military bases and weapon missiles, strengthening border defense system construction, immigration, and other expenditures.

How does OBBBA affect the U.S. economy and U.S. stocks?

OBBBA boosts the U.S. economy in the next two years, but the impact may be weaker than the 2017 tax cut law. Most institutions predict that OBBBA will drive economic growth in the short term, with an increase in U.S. economic growth rate between 0%-0.6% for 2026, gradually decreasing after 2028, and potentially leading to a decline in long-term economic growth. Compared to the 2017 tax cuts, both short-term and long-term impacts may be somewhat weaker.

On July 3 local time, the U.S. House of Representatives passed the "Great Beautiful Act (OBBBA)" with 218 votes in favor and 214 votes against, without any modifications to the Senate version. On July 4, U.S. President Trump officially signed the bill.

What are the main contents and changes of OBBBA?

1) An increase of $3.4 trillion in the basic deficit and $700 billion in interest expenses over 10 years. OBBBA stipulates a net increase in the basic deficit of $3.4 trillion over the next 10 years, including $4.5 trillion in tax cuts, $1.4 trillion in spending reductions, and $300 billion in increased spending, plus $700 billion in interest expenses, resulting in a total deficit of $4.1 trillion and an increase in the debt ceiling of $5 trillion. Overall, this is an increase of $1 trillion compared to the House version (which had a total deficit of $3 trillion and a debt ceiling of $4 trillion).

2) The fiscal deficit rate may be around 7% over the next 3 years. Although the Senate version significantly increased the net deficit after 2030 compared to the House version, the main fiscal expenditures still occur in 2026-2028. According to CBO estimates, OBBBA will bring a net increase in the deficit of $1.6 trillion during 2026-2028, accounting for about 50% of the 10-year coordinated plan, corresponding to a fiscal deficit rate of around 7% for 2026-2028 (significantly higher than 2024-2025). This is because the main increases in spending (military, immigration expenditures) occur in 2026-2028, while the main reductions in spending (medical subsidies, food voucher subsidies) are reflected after 2029.

3) In terms of tax cuts, first, important provisions are made permanent. For individual income tax, the 2017 TCJA individual income tax is made permanent, along with the estate tax exemption and child tax credit; for corporate tax, the corporate income tax is not further reduced from the 21% base, but the four major deductions—research and development expenses, net interest, additional depreciation, and qualified business income (QBI)—are all made permanent, and the tax incentives for impoverished communities, namely the Qualified Opportunity Zone (QOZ) program, are also made permanent. Second, special provisions apply only to Trump's term (2025-2028), including the elimination of the small tax, overtime tax, and auto loan interest tax, with the SALT deduction cap increasing from $10,000 to $40,000 starting in 2025, increasing by 1% each year until 2029, and reverting to $10,000 in 2030; In terms of corporate taxes, a 100% expense tax incentive is provided for eligible real estate structures (factories, warehouses, etc.), but construction must start between January 19, 2025, and January 19, 2029, and be put into use before December 31, 2030. Third, some tax incentives will be abolished, including the termination of expenditures related to Biden's "Green New Deal," the cancellation of certain social welfare program expenditures, and the abolition of tax exemptions for individuals and dependents.

4) The reduction in expenditures mainly reflects in medical subsidies, clean energy subsidies, and food voucher programs, with reductions of $1,074 billion, $543 billion, and $114 billion respectively over the next 10 years, while military, homeland security, justice, and the Homeland Security Committee will receive an increase in the deficit of $288 billion over the next 10 years, mainly for improving military bases and weapon missiles, strengthening border defense system construction, immigration, and other expenditures.

How will OBBBA affect the U.S. economy and U.S. stocks?

OBBBA will boost the U.S. economy in the next two years, but the impact may be weaker than the 2017 tax cut legislation. Most institutions predict that OBBBA will drive economic growth in the short term, with a boost to U.S. economic growth in 2026 estimated between 0% and 0.6%, gradually decreasing after 2028, and potentially leading to a decline in long-term economic growth. Compared to the 2017 tax cuts, both short-term and long-term impacts may be somewhat weaker.

The tax cuts will benefit the middle class in the short term, but long-term benefits will still favor high-income groups. Due to certain special provisions only applicable during Trump's term (2025-2028), the short-term growth rate of residents' income is significantly higher than the long-term. Compared to 2025, income growth rates for different groups will increase in 2026, with an overall increase of 5.4%, where the middle class's income growth rate will rise more than that of low-income and high-income groups, benefiting from tax credits for overtime pay, tips, etc. However, by 2034, the income growth rate for high-income groups will exceed that of the middle class, while the low-income group's income growth rate will decline by 0.4%, partly due to the expiration of tax credits for overtime pay, tips, etc., and partly because the increase in the SALT deduction cap will be more favorable for high-income earners in high-tax states, without the establishment of capital gains tax or wealth tax.

The tax cut legislation will still provide a positive boost to U.S. stocks in the next two years. The U.S. deficit rate will be around 7% in the next two years, significantly higher than in the past two years, and the current performance of U.S. stocks has already priced in the positive fiscal factors. In addition, AI capital expenditures are still expanding, and the logic of stablecoins will provide liquidity support for U.S. stocks. Even if U.S. Treasury bond yields do not decline further, there is still upward potential for U.S. stock valuations. Therefore, we remain bullish on U.S. stocks ahead of next year's midterm elections. Returning to the present, we do not rule out short-term adjustments due to weakening inventory cycles, escalating tariff frictions, and rising inflation, but adjustments present good opportunities for increased allocation.

Is there significant pressure on long-term bond supply? If the Treasury Department provides expectations for increased long-term bond issuance, there will be upward pressure on U.S. Treasury yields, but it is relatively controllable. From June to October 2023, short-term rates rose by over 30 basis points, long-term bonds rose by over 130 basis points, and term premiums rose by over 150 basis points. Therefore, the rise in long-term bond yields mainly comes from term premiums, which are compensated by the strengthening of debt risk narratives, corresponding to the Treasury Department's refinancing meetings in Q2 and Q3 of 2023, which provided forward guidance on future long-term bond issuance According to the statement from the Ministry of Finance's Q2 refinancing meeting on April 30 this year, the Ministry expects to maintain the pace of long-term bond issuance unchanged for at least the next few quarters. Attention will be paid to whether this statement will continue in Q3; if it does, there should not be significant issues with long-term bond supply. However, if an expectation of increased issuance is given, there will be some upward pressure on long-term bond rates, but it is relatively controllable. The repurchase by the Ministry of Finance starting in 2024 is aimed at buying back high-yield government bonds issued earlier when rates were low, alleviating overall interest payment pressure. However, the two single repurchases of 10 billion that began in June this year set a new high since 2000, and the approach may differ from before, primarily aimed at rescuing the U.S. bond market. During the two repurchases, the 10Y U.S. Treasury bond rates were 4.51% and 4.47%, respectively, suggesting that 4.5% may be a key level in the minds of policymakers