Via Lance Roberts of StreetTalk Live [11],
By now there is likely not a single individual who is not aware of the impending "fiscal cliff" and the economic impact that it represents. (For a thorough discussing of the taxes involved you can find a complete listing here [12].) Then there is the debt ceiling issue. Both of these issues will be topics of hot debate in the coming days ahead with implications to the stock market in the short term that could be potentially damaging as investors scramble avoid a hike in tax rates.
Obama, and the Democratic controlled Senate, have already lined up on raising taxes on the "rich" while the Republican controlled House has firmly asserted that they are amenable to closing tax loopholes in conjunction with spending cuts. The two sides could not currently be farther apart from reaching a deal - yet, as Yoda would say: "Reach a deal we must."
Logic says that both sides will come to the negotiating table with compromises to resolve the fiscal cliff issues. The Republicans could concede to following without a tremendous backlash from conservative right:
- Increased taxes on individuals making $500,000 or more rather than the $250,000 level current proposed.
- Closing of tax loopholes and deductions (i.e. capping deductions at $50,000 and getting rid of Carried Interest)
- Letting the payroll tax cut expire at the end of the year.
- A reset of the Alternative Minimum Tax with an inflation adjustment.
- A modified bump in the capital gains and dividend tax rates to 25% from the current level of 15%.
- A repeal of the automatic spending cuts which were imposed during the previous debt ceiling debate.
However, such deep concessions by the Republicans should be readily met by the Democrats agreeing to actual significant spending cuts including:
- Start entitlement reform by raising the eligibility age to 70 for those currently under the age of 55.
- Means testing of entitlements for all individuals below the age of 55.
- Elimination of extended unemployment benefits
- Cuts in discretionary spending which will include further cuts in defense spending.
- Elimination of the Presidential Campaign Fund
- End funding for new federal office space
- Repeal of the Davis-Bacon Act
- Eliminate funding for the National and Community Services Act
- Eliminate duplicate education programs
- Cut the Federal travel budget
- Privatize Fannie Mae and Freddie Mac....again.
It is likely that such a bipartisan compromise could be quickly agreed upon and executed before the end of the year deadline. I realize that there are many other levels of cuts that could be made that could effectively save billions each year in government waste, however, this would at least be a significant start and lay the foundation for further compromise in the future.
Yet, this is an unrealistic expectation.
The Democrats have given no indication that they will compromise on any front and that tax hikes are all that is available for discussion. Likewise, the stance by the Republicans is just as firm as they stand behind their pledge of no tax increases. However, in the end, it will be the Republican led house that will again define "insanity" by repeating the same mistakes of their past.
In the next few days as the "fiscal cliff" draws nearer that media pressure from the White House will intensify to a fevered pitch with threats of economic recession due to Republican's unwillingness to compromise. Make no mistake - the blame for what ails this economy will be squarely pointed at the "evil and selfish" Republican's who are keeping Obama from being able to achieve the greater good for the economy.
This is the same tactic that was used during the debt ceiling debate in 2011. Then the threat was a default on U.S. debt due to the inability to raise the debt ceiling which culminated in a debt rating downgrade by Standard & Poors. Of course, a simple look at the U.S. Treasury market, as yields touched historic lows at the time, would have told any astute individual that a default was of no concern. Yet, the Republican's caved to the pressure and raised the debt ceiling in exchange for a committee to come up with spending cuts later. The committee failed, automatic spending cuts were implemented and immediately postponed. Those automatic spending cuts are coming back January 1st, 2013.
Like George H.W. Bush who caved on his pledge of "No New Taxes" in exchange for future significant spending cuts which never materialized, the Republican's also caved and raised the debt ceiling in exchange for empty promises. That is the reality that Republican's again face in the current debate and the mistake that they are likely to repeat.
In the coming days ahead, as the White House intensifies the pressure, the Republicans will once again crater to demands. They will agree to higher taxes with a "promise" of future spending cuts. The problem, of course, is that once tax hikes are in place there will be no need for future negotiations. The government will continue to run without a budget and spending will continue to spiral higher.
The sad reality that escapes our current Administration is that the long term solution to economic stability is a balanced approach to both increasing revenue and cutting spending. A serious amount of work and compromise will be required, with an understanding that increasing revenue through taxation while cutting spending means slower economic growth, in the short term. Yet, it is the understanding that slower economic growth is the "short term pain" required to establish the stable economic foundation from which "long term gains" may be achieved.
We will see what happens in the days ahead. While hope in the market abounds for a successful compromise - it may pay to remain hedged against the risk of failure of our elected officials to come to a moment of clarity and act like adults.