Third Quarter 2021 U.S. Economic Outlook: Vaxed, Taxed, and Roaring Back

It’s been a year and a half since the onset of COVID-19, and there’s encouraging news for clients. The U.S. economy is bouncing back to life thanks in part to government aid and relatively high vaccination rates. The national economy grew at a seasonally adjusted, 6.5% annual rate in the second quarter, a sign that the nation has achieved a sustained recovery from the pandemic-induced recession. In fact, the economy has now surpassed its pre-pandemic levels.

Most importantly, profit margins are strong despite rising inflation and reports of higher costs which many economists view as short-term. Net profit margin for the S&P 500’s second quarter is expected to be 12.4%, according to a FactSet Research Systems’ senior earnings analyst.  If that turns out to be the actual net profit margin for the quarter, it will be the second-highest for the index since FactSet began tracking the metric in 2008, trailing only last quarter’s net profit margin of 12.8%.

The economy expanded at its fastest pace since last fall, but at a slower rate than the 8.5% growth rate that analysts had expected. That was mainly because supply chain bottlenecks and labor challenges exerted a stronger-than-predicted drag on many businesses as they sought to restock their shelves and hire staff. The drag on inventory rebuilding, in fact, was responsible for subtracting 1.1 percentage points from last quarter’s growth.

Corporate Earnings On-Track to Soar

In terms of corporate earnings, the S&P 500 is on track for its best quarterly earnings growth since 2009. So far S&P 500 companies have posted revenues well above end-of-quarter estimates; beating those estimates by a wider than average margin. Technology, energy, and industrials, posted some of the best performances. Analysts also expect double-digit earnings growth for the second half of 2021.

Those reporting robust second quarter earnings include American Express Co. (AXP.N), which posted second quarter net income of $2.3 billion, or $2.80 a share, up from $257 million, or $0.29 cents a share a year ago. Social media firm Twitter (TWTR.N) stunned Wall Street with earnings that blew past estimates, posting revenue growth of 74% over last year; the fastest since 2014.

All three major U.S. stock indices—the Dow Jones Industrial Average, S&P 500 and Nasdaq—rallied to record highs.  DJIA closed with a gain of 238.20 points or 0.68% at 35,061.50 to finish above 35,000 for the first time ever. The S&P 500 (.SPX) gained 44.31 points, or 1.01%, to 4,411.79. The Nasdaq Composite (.IXIC) added 152.39 points, or 1.04% to close at 14, 836.99. 

The economy is also receiving substantial support from the Federal Reserve. The Fed reaffirmed that it will keep its interest rates anchored near zero in the short term to encourage borrowing and spending. In a statement after its last policy meeting, it also reported that it will continue buying $120 million in government-backed bonds each month to keep longer-term borrowing rates low. However, given the magnitude of the economic rebound, the Fed signaled that rate hikes could begin in 2023.

Outlook is Rosy Despite Fears    

Although investors are concerned about the possible impact of the COVID-19 Delta variant on the global economy, the general expectation is that economic reopening will continue across major developed economies well into the second half of 2021.

Even with uncertainty about the path of the pandemic, the IMF  recently raised its projection for economic growth in 2021, the second time it has done so this year. The international organization expects the U.S. economy to expand 7% in 2021 and 4.9% in 2022, up from the 3.5% it projected a few months ago.

But the quickening growth—spurred by large spending packages proposed by President Joe Biden—have some analysts worried that inflation could rise too fast. Already, raw materials and parts, including semiconductors and copper, have spiked in price as demand has outstripped the ability of suppliers and shippers to keep pace.

As a result, some companies such as consumer products giant Procter & Gamble and Honeywell, maker of industrial and consumer goods, have said they plan to raise prices to offset rising costs. However Fed Chair Jerome Powell has said he expects such supply bottlenecks to lead to temporary price increases only, rather than a prolonged bout of accelerated inflation.

GILTI: Changes Ahead

President Biden has proposed to make substantial changes to the tax burden on foreign income through GILTI (global intangible low-taxed Income). The GILTI tax rate has been 21 percent, but the 2017 Tax Cuts and Jobs Act (TCJA) also allowed corporate taxpayers to deduct 50 percent of their GILTI income, which brought the effective tax rate down to 10.5 percent.

The Administration’s crackdown keeps the GILTI rate at 21% but eliminates the 50% deduction, meaning that multinational corporations would pay a higher minimum tax rate. This rate to be determined on a country-to-country basis, would eliminate the ability of corporations to offset losses incurred in one country against income earned in another. Under current law, income in a low-tax rate country can be blended with higher-taxed income and be either reduced or eliminated entirely. Once implemented, the changes will have significant ramifications for multinational corporate taxpayers in 2022, resulting in a higher effective tax rate on foreign income.  

Be Prepared for the New Tax Paradigm

With a global corporate tax policy on the near horizon, revisions to the TCJA and the Fed’s new policies on squashing well-established tax loopholes and challenging tax havens, international tax clients need to prepare now for the imminent changes ahead.

Mitigate your tax debt and build wealth with strategic moves and planning. Contact our office for a consultation with Jack Brister.