We’re hearing a lot about the fiscal cliff in this post-election time period, and surprisingly, considering the angry partisanship of the campaign, some of the news is encouraging. The White House and Congressional leaders, elected officials from both sides of the aisle, are saying that they believe they can reach agreement before the end of the year.
The “fiscal cliff refers to a lot of different tax and budget provisions that are all scheduled to take place automatically at midnight on December 31. These include higher tax rates, loss of deductions, random across-the-board budget cuts and expiration of stimulus measures (payroll tax cuts end).
Why do we call this a “cliff?” Because everything on that list would take money our of the hands of taxpayers and, at the same time, lower government spending–essentially providing the U.S. economy with the opposite of a government stimulus, what some have called a hard punch to the gut. The Congressional Budget Office estimates that if we go over the cliff–that is, if Congress and the President don’t act between now and the end of the year–a total of $560 billion would exit the economy.
So what are the odds that Washing to will get its act together and choose a course that doesn’t take us over the cliff? As it happens, there is reason to hope. Leaders on both ends of the partisan divide agree on many things in this negotiation: that the tax cuts are too painful and random to allow in their present form, and that tax rates on American taxpayers with less than $250,000 in income should continue as they are today. The sticking points are if or how much tax rates should rise for Americans in the higher tax brackets, and where to apply the budget knife.
As you follow the debate, pay attention to whether our elected officials are actually tackling the issues or just kicking the can down the road yet again. If you hear discussion about permanent laws, such as a balanced budget amendment, or a framework that forces Congress to offset any expenditures with cuts elsewhere, or a change in tax rates, or some kind of entitlement reform (Means testing? Raising eligibility ages?), that will be a sign that Washington is getting serious about addressing real issues.
If, on the other hand, you hear about caps on future appropriation bills, or solutions which sunset in 12 or 24 months, that means that we’ll be going through a version of this debate for the foreseeable future, and the can could be kicked, once again, far enough down the road to become a 2016 Presidential election issue and a headache for the next President to deal with.
The US equity markets appear accustomed to a period of political pasturing as both parties attempt to extract as much as possible from the negotiations. Given that neither party has an interest in failing to compromise, as the repercussions from an economic and reputational perspective would be great, we do not expect the US to fall off the “cliff” in its full form. As “11th hour” decisions have become the norm in DC, we expect more constructive discussions and an interim solution to evolve as Christmas approaches.
Ronald E. Wilkinson, CFP®, Stacy L. Rerick, CFP®, Evan S. Russell, CFP®