Try as I might to steer clear of talking politics, it is front and center again. While analyzing investments and providing financial market outlooks aren’t easy jobs in any environment, they certainly aren’t in one that seems to have a new “bogeyman” around every corner.
Whether that would be slow economic growth here in the U.S., the pending doom of the Eurozone, a slowdown in China or new Middle East tensions, the mantra that “markets climb a wall of worry” never seems more true than today. Adding to all of this worry is the political environment in the U.S. and the upcoming “fiscal cliff” at the end of the year.
Who’s your money on?
While the upcoming election is one thing that I am not going to touch on much, I do look at the Iowa Electronic Markets website to see what the election odds look like. Real people are putting down money to essentially bet on the outcome. Right now it appears as though President Obama will be re-elected and Republicans will gain control of Congress. So, going with that as an outcome, what does the end of the year hold for investors worrying about the “fiscal cliff”?
First of all, what is the “fiscal cliff”? Well, at the end of the year, without new legislation, you get a combination of:
- tax increases through the expiration of the Bush tax cuts and the temporary payroll tax cuts along with
- some spending cuts in several discretionary budget areas.
Basically, if this happens, according to the Congressional Budget Office (CBO), the U.S. economy will likely fall into recession in the first half of 2013.
What’s over the precipice?
This chart from the CBO’s website presents two scenarios: the CBO’s Extended Baseline (if the fiscal cliff occurs) and the CBO’s Extended Alternative (if most current policies are extended). Interestingly, Debt-to-GDP and the Budget Deficit are improved dramatically if the fiscal cliff were to happen as opposed to extending it out. The problem here again is the short-term economic ramifications of allowing this to occur.
Taxes reverting back to pre-Bush era will affect everyone. Tax rates go up across the board.
- The individual income tax rates will revert to 15, 28, 31, 36 and 39.6 percent.
- The capital gains rate will increase to 20 percent and dividends will be taxed at ordinary income rates.
- The 10 percent bracket is eliminated hurting lower income earners.
Also don’t forget, estate taxes will jump from 35 percent to 55 percent! Just thinking about this probably is giving accountants everywhere a headache!
The fiscal cliff is a big unknown right now as it will unlikely be resolved by the end of the year given the election. So, while we may get some retroactive relief passed next year, investors won’t know exactly what that will look like.
If the Iowa Electronics Markets election outcomes prove correct, can the Republican Congress and President Obama work together to hammer out a compromise that will help ease the severity of the “Fiscal Cliff”? Since everyone is impacted by this, rich and poor, there may be more incentive than usual to compromise, but it might not be pretty.