As I write this, it’s been exactly one year since Donald Trump won the 2016 presidential election in a shocking upset … and what a year it’s been. A lot has happened, a lot hasn’t and a lot may still come to pass between now and the end of the year.
The Status Quo? Not So Bad
Before discussing the prospective effect of potential legislation and policy changes on equipment demand in 2018, it’s worth taking stock of the status quo, which is pretty good considering the uncertainty in Washington, D.C.
The federal highway bill enacted at the end of 2015 provides certainty for road and bridge programs through fiscal year 2020 and authorizes $41.4 billion for the core highway program in 2018. That investment will generate an estimated $2.65 billion in equipment demand next year and support roughly 4,300 equipment dealership jobs. But keep in mind, that’s just the impact of federal money. States generally must put up 20% of the cost of a federally-funded project, so the actual value of the investment induced by federal spending in 2018 will be around $50 billion, which will lead to approximately $3.18 billion in equipment market activity.
Several other federal construction programs affect equipment demand. The Clean Water and Drinking Water State Revolving Funds (SRFs), respectively, provide resources for local sewer and drinking water projects. In 2017, the CWSRF received $1.39 billion and the DWSRF about $900 million. Although the SRFs are much smaller than the highway program, one dollar spent on water infrastructure has almost twice the equipment market impact as a dollar spent on roads. Assuming Congress appropriates the same amount for the SRF in 2018 as in 2017, I estimate the SRFs will support roughly $275 million in equipment market activity collectively next year. Legislation to more than double DWSRF funding is pending in the House but unlikely to move on its own this year. It’s more likely to be wrapped into a bigger infrastructure bill.
The Federal Aviation Administration (FAA) manages the Airport Improvement Program (AIP), which funds airport projects. The AIP currently receives around $3 billion per year. Estimating conservatively that the market impact of airport construction is similar to roads, the AIP generated roughly $180 million in equipment demand in 2017. I don’t expect FAA construction programs to receive less next year, but they may receive more in coming years.
Regulatory Reform
Direct funding aside, new regulatory posture at the federal level is likely to have a positive effect on equipment demand and the construction industry in general. The president’s regulatory accomplishments are his most important to date.
From his first day in office, President Trump made regulatory reform a priority. He has signed more than a dozen resolutions passed by Congress under the Congressional Review Act (CRA) undoing regulations adopted during the last year of the Obama administration. While intelligent people will disagree about the merits of the regulations repealed under the CRA, Congress and the administration have demonstrated how effectively it can be used to undo policies put in place by the new president’s predecessor.
The White House is also pushing regulatory reform within the executive branch from the top down and bottom up. The president issued several executive orders relating to regulatory issues, including requiring two regulations to be repealed for each new regulation issued, a net-zero economic impact of newly adopted regulatory policies and the formation of bodies within every agency to review regulations and recommend improvements.
Trump’s department and agency heads have also sought to undo Obama-era regulations they believe are harmful to the economy. Two regulatory actions likely to affect equipment markets are the Environmental Protection Agency’s move to rescind the Waters of the United States (WOTUS) and carbon emissions rules. Many in the construction industry feared WOTUS would delay or prevent new projects from moving forward, and rescinding the rule should provide peace of mind to developers and generally help construction activity. Removing the carbon rules is likely to have an effect on distributors that support the coal industry.
Bonus depreciation is the final status quo consideration relating to equipment markets in 2018. The 2015 tax law extended the depreciation bonus through 2019, but it is set to fall from 50% to 40% in 2018. Even with the 10% drop, new equipment purchasers (this special capital investment incentive only applies to new equipment) will be able to immediately write off 40% of their purchases. Traditionally, bonus depreciation was a powerful inducement to capital investment at the tail end of an economic downturn, but because it has become part of the tax landscape, it’s not the incentive it used to be.
With that evaluation of the status quo in mind, let’s shift to the many unknowns.
2018 Appropriations Hanging in Limbo
Enormous uncertainty surrounds the federal budget and other federal spending programs that affect equipment demand. Congress appropriated money to keep government spending in fiscal year 2018 (which started in September) at current levels through early December, which means between the time I write this article and the time you read it, one of several things may have happened. Most likely, Congress and the president kicked the can down the road again (probably to the spring) to keep the government running while they work out a final fiscal year 2017 spending deal. In the best-case scenario, they funded the government through next September at roughly current levels. In the worst-case (and least likely) scenario, we’re in the middle of a government shutdown.
Hints, But Nothing Definite on Trump’s $1 Trillion Infrastructure Plan
Although I’d generally characterize the administration as pro-infrastructure, the massive federal infrastructure program President Trump promised on the campaign trail has taken a back seat to other priorities. However, the administration’s first budget, released earlier this year, provides clues about the president’s intentions to reform “how infrastructure projects are regulated, funded, delivered and maintained.”
The budget acknowledged the president’s widely-publicized goal of investing $1 trillion over a decade, but sought to manage expectations by saying that target “will be met with a combination of new federal funding, incentivized non-federal funding and expedited projects that would not have happened but for the administration’s involvement.”
The administration’s infrastructure priorities identified in the budget include targeting investment towards “transformative projects,” encouraging states and localities to raise their own dedicated revenues for infrastructure, spinning off certain infrastructure-related functions the administration believes could be better handled by the private sector and heavier reliance on the private sector to maintain and finance projects.
One of the ways the president wants to encourage more private investment is by expanding the Transportation Infrastructure Finance and Innovation Act (TIFIA) Program. According to the administration, “one dollar of TIFIA subsidy leverages roughly $40 in project value. If the amount of TIFIA subsidy was increased to $1 billion annually for 10 years, that could leverage up to $140 billion in credit assistance and approximately $424 billion in total investment.” The president also wants to lift the cap on private activity bonds and expand their eligibility to other non-federal public infrastructure.
The administration is expected to release more details about its infrastructure plan this fall and turn to that topic after Congress completes a tax bill. Which leads us to …
Tax Reform Hangs in the Balance
The political class in Washington has been gearing up for a tax reform debate for many years, and it seems to finally be upon us.
One important area is expensing and business interest deductibility. The tax reform bill proposed by the House GOP would increase bonus depreciation to 100% through 2022 and eliminate the long-standing requirement that property be new to qualify for bonus depreciation. The bill would also increase the maximum amount a taxpayer may expense under section 179 to $5 million and increase the phase-out threshold amount to $20 million through 2022. However, the tax bill would also impose new limits and restrictions on the deductibility of business interest, which would inevitably play into equipment acquisition decisions.
Other items in the tax bill could also affect construction activity and equipment demand. Like-kind exchange (LKE) has become an important tool to manage the consequences of buying and selling equipment; the tax bill would disallow LKE for personal property like construction machinery. Housing starts have traditionally been considered an important indicator of the health of the equipment industry. Organizations representing homebuilders are very concerned that reducing the mortgage interest deduction, as the House GOP has proposed, would hurt the housing market. The bill would make interest from private activity bonds taxable and therefore potentially less attractive, hurting financing for construction projects. And many in the construction industry are disappointed that the bill doesn’t contain any new revenue streams for infrastructure projects such as an increase in the gas tax or other new highway user fees.
Finally, the tax bill may affect infrastructure and equipment demand in another way. At the outset of the tax reform process, the goal was a deficit-neutral bill, so tax reform wouldn’t add to the national debt. However, the budget resolution Congress adopted earlier this year would allow borrowing of up to $1.5 trillion to pay for a tax cut. If Congress actually gets a budget-busting tax bill on that scale done, will there still be an appetite on Capitol Hill to spend/borrow $500 billion or more for a new infrastructure package?
There are a lot of pieces left to fall into place. My bottom line is, regardless of what does or doesn’t happen on the Hill in the next few months, equipment demand in 2018 will be much like it was in 2017 … and that’s not such a bad thing.
