The Independent Market Observer

1/2/13 - Hooray

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jan 2, 2013 6:05:40 AM

and tagged Fiscal Cliff, Politics and the Economy

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The news this morning is that at the last minute, after actually going over the cliff, our government officials have successfully covered their butts and kicked the can down the road for another two months. If that doesn’t sound like a ringing endorsement, it isn’t.

Let’s look at what the legislation actually does. Today, the Washington Post published a good cheat sheet.

Things that have a short-term effect are:

  • Federal unemployment insurance for those unemployed for more than 26 weeks has been extended.
  • Sequestration has been delayed for two months.

Longer-term effects include:

  • The Bush tax cuts have been made permanent for individuals with incomes below $400,000 and for couples with incomes below $450,000. Rates for people above that threshold have been increased. This is the first increase in income tax rates in more than two decades.
  • Over the same threshold, tax rates for capital gains and dividends have been increased to 20 percent but will remain 15 percent below the threshold.
  • The Alternative Minimum Tax has been permanently patched to avoid affecting the middle class.

You will note that the short-term items are designed to avoid any political pain for either party, as Democrats get extended unemployment insurance and Republicans postpone defense cuts. The longer-term items also play to politics, with the Bush tax cuts made permanent for more than 90 percent of Americans to cater to Republicans and higher taxes agreed to for the “rich” to appease the Democrats. Politically, a very successful package.

What this package does not do is actually address any of the fundamental economic issues. A target of around $4 trillion in deficit reduction had been laid out as what would have been needed. The deal that Congress passed gets us to around $600 billion in deficit reduction—or about 15 percent of what was supposed to have been necessary. This is not even a down payment.

This also leaves a significant portion—about two-thirds—of the Republicans in the House even angrier than before. Fully 151 of 236 Republicans voted against the bill. John Boehner and Paul Ryan voted for it, but Eric Cantor, the number two Republican, voted against it. None of the Republican leadership spoke in favor of the bill. Not a good setup for the next round of negotiations.

This was presumably the last act of this Congress, with the next one scheduled to take office later this week. The next Congress is actually seen as more partisan, with more members on the outer edges of each party, which again does not bode well for the next round of negotiations . . . which will be coming soon.

The debt ceiling will hit in the next couple months, and the sequestration—forced spending cuts—discussion has only been postponed for two months. In two months, we will therefore be having exactly the same kind of drama, not only about sequestration again, but also with the 2011 debt ceiling crisis negotiations layered on top.

We also have to deal with the remaining 85 percent of the required deficit reduction, whether in tax increases, which will be harder now that tax rates have been agreed to on the vast majority of the population, or spending cuts, which is a battle that has not even started.

The positive side of this agreement is that first, it demonstrates that Congress can get something done if enough pressure is applied, and second, by extending unemployment insurance and not increasing taxes, it should support continued growth in consumer spending and the economy as a whole. We have avoided the short-term hit that failure to agree would certainly have made.

What we have not done is actually solved any problems. By pushing them down the road, we have in effect created an even bigger drama, with much worse potential consequences, a couple months from now.


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