Preventing the Fiscal Cliff is a Tall Order
I presume by now that most everyone reading this is familiar with the term fiscal cliff. But just to review quickly, here is what is set to happen on January 1, 2013 if nothing is done to stop it:
1.. The automatic expiration of the Bush tax cuts for everyone;
2.. The automatic end of the 2% payroll tax holiday;
3.. Extended unemployment compensation comes to a close;
4.. The automatic spending and budget cuts mandated by the Budget Control Act if
Congress failed to reach the SuperCommittee’s deficit reduction goals (which it did).
If these four things are allowed to happen, the economic damage to the economy would amount to at least $500 billion (I think it will be more), or some 3.8% of Gross Domestic Product at a time when GDP is struggling to grow by even 2%. The Congressional Budget Office recently estimated that if all the Bush tax cuts expire at the end of the year, the US economy will fall into recession in the first half of next year with negative GDP growth of -1.3%. That estimate doesn’t even take into account numbers two and three listed above.
It now appears that there will be no effort in Congress to address the fiscal cliff issues listed above until after the election, which I think is very dangerous. The Lame Duck Congress will have less than seven weeks (if you subtract holidays) to address some or all the issues noted above before year-end.
Most analysts contend that the danger of the fiscal cliff is not on the front burner with most Americans; instead they claim that it’s the European debt crisis that has investors’ attention. I would argue that the fiscal cliff is increasingly on the minds of investors and the general public. As an example, Fed Chairman Bernanke warned Congress repeatedly about the fiscal cliff in his testimony and comments in June. This is a big deal, especially if Congress waits until November 7 to tackle it. Think recession.
No, the Fiscal Cliff Will Not be a Big Deal
To be fair, I should point out that there are some in the financial media who do not believe that the fiscal cliff will be a problem. Obviously, there are those who believe that the Lame Duck Congress will be successful in: 1) extending all of the Bush tax cuts, or at least most of them; 2) extending the 2% payroll tax holiday; 3) extending unemployment benefits; and 4) delaying the automatic spending cuts required by the Budget Control Act. If all of this gets done by December 31, I would agree. But with the angry partisanship within the Congress, there is no guarantee it will get done. Even if Congress can get it done, then there is the question of whether or not President Obama will sign the measures into law. Let’s take the Bush tax cuts, for example.
Earlier in June, Rep. Nancy Pelosi shocked politicos on both sides when she sent a letter to House Speaker John Boehner recommending that the House make permanent all of the Bush tax cuts for all Americans making less than $1 million a year. Wow! This is Nancy Pelosi after all. Over the next couple of weeks, several prominent Democrats got onboard as well.
Even former President Bill Clinton weighed in stating that he didn’t think income taxes should be raised on anyone (or spending cut) until the economy improves significantly. He even suggested that the economy is now in a recession. Oops!! A couple of days later, he reversed his position and apologized for differing with Obama.
As this idea for making the Bush tax cuts permanent for those making up to a million dollars developed, I got the feeling that there might even be enough Republicans that could sign onto this plan to get it passed. There was an assumption that President Obama might even go along.
However, in the middle of June, the president’s Press Secretary made it very clear, that Obama would veto any tax plan that didn’t eliminate the Bush tax cuts for individuals making over $200,000 and families making over $250,000. Here we go again!
Those who downplay the risk of the fiscal cliff seem to believe that even if the Lame Duck Congress doesn’t get everything done by December 31, then surely the new Congress will get it done in January or February, and make everything retroactive to January 1. That might sound good on paper, but that much uncertainty and fear will almost certainly be negative for the economy and the stock markets.
If the Bush tax cuts expire, whether for everyone or just those making over $200K/$250K, income taxes will go up. Some argue (ignorantly) that taxpayers won’t feel the pain of higher tax rates until 2014 when they file their 2013 tax returns. That ignores the fact that withholding will go up on January 1 for those facing higher taxes.
As noted above, the 2% payroll tax cut will also disappear, immediately affecting paychecks. Likewise, the capital gains rate will also increase significantly. If that looks likely near the end of this year, we could see a big increase in sales of assets that are subject to capital gains before year-end.
I should also mention that there are several other temporary tax incentives that will expire at the end of this year if no action is taken by Congress and the president. These include a reversion to Clinton-era estate and gift tax rules, the so-called Medicare Doc fix, the AMT patch, etc. All of these will revert to more onerous levels if nothing is done by December 31.
Finally, you may be asking why Congress and the president are intent on not taking action on any of these issues until after the election. Good question. In a nutshell, procrastination until after the election is (in a twisted way) the safest option because any resolution of these highly-charged issues beforehand will be very controversial on both sides.
During the election campaign, both Democrats and Republicans want to emphasize their differences on tax and spending policies. Partisans view reaching a common agreement before the election as blurring distinctions that would otherwise be emphasized. If you find this disgusting, you’re right! They are risking a recession next year so they can get re-elected.
Gary D. Halbert is the president and chairman of Profutures, Inc. Subscription rates for Forecasts & Trends is $197 for 12 issues and may be obtained by visiting his website at www.profutures.com.