My Thoughts on the U.S. Fiscal Cliff Agreement in Washington
January 2, 2013
The stock market rallied strongly today on yesterday’s news of a fiscal cliff agreement in Washington. It was a “relief rally”, as the market was concerned about the significant tax hikes and spending cuts which were set to start on January 1, 2013. Is it a good deal for investors and Americans? What is our initial reaction to this agreement?
Fiscal Cliff Agreement Positives:
- Overall this agreement is positive in the short term for the stock market, as it is not as bad as the worst case scenario on taxes. It is much better than was expected, especially regarding taxes, if no agreement had taken place. The agreement is negative in that it increases taxes, especially on high income taxpayers, but it could have been much worse. Some tax increases were likely needed and inevitable.
- The agreement reduces much of the uncertainty about personal income tax rates, we hope. Corporate tax reform is still a big question mark. After the agreement, President Obama has said he will seek additional revenues (tax hikes) over the next few months in exchange for making spending cuts.
- Dividend taxes for high income taxpayers are “only” going up to a maximum of 23.8% from 15%. With no agreement in place, dividend tax rates were scheduled to rise to ordinary income tax rates of over 40%. For many taxpayers with incomes below $450,000 the dividend tax rates will stay the same at 0%-15%.
- The income level to trigger the higher tax rate of 39.6% was increased from the initial Obama proposal of $250,000 per family up to $450,000 per family. Income taxes will still be going up for families with incomes over $250,000 because deductions will be phased out and due to the new Obamacare 3.8% tax on investment income and capital gains.
- The federal estate tax exemption stays at $5 million per person, rather than falling to just $1 million as was planned. In addition, this exemption is indexed to inflation going forward. This will protect the assets of couples with estates valued at $10 million or less.
- The agreement included a permanent adjustment or “fix” to the alternative minimum tax, and finally indexed it to inflation as it should have been all along.
Fiscal Cliff Agreement Negatives:
- This agreement does NOTHING to cut spending or entitlements. They completely kicked the can down the road on the biggest problems.
- It just delays the significant political debate and drama over the next two months over spending cuts, entitlements cuts, and the debt ceiling. We believe investors should expect more stock market volatility over the next several months.
- This agreement does very little to fix the debt and deficit problems. No tough choices were made by Congress. It addresses the “redistribution” goal more than the “reduce the debt/deficit” goal or the “grow the economy” goal.
- It seems like Congress and the President are unlikely to agree to any real or significant spending or entitlement cuts. We have a spending problem. This agreement increases some taxes now but goes with the “just trust us” on spending cuts later. Politicians love to give away other people’s money (or borrowed money), but are not very good at taking things away or making tough long-term decisions.
- There is still the potential for the rating agencies to downgrade the U.S. credit rating based on the lack of any real progress on deficit reduction, or if the Congress comes close to or breaches the debt limit. The last time that happened it resulted in a significant drop in the stock market.
- The whole fiscal cliff debate and agreement is just another reminder of how dysfunctional Washington has become. Our leaders are too short-term oriented, and they are unable to make any tough decisions no matter how important they are for the long-term good of the country. Their time horizon is always the next election 2-4 years away, rather than doing what is best for our children and grandchildren. The odds of a serious agreement to significantly address our debt/deficit problem seem remote, given the partisan politics in Congress.
The Bottom Line for Investors:
The stock market is rallied today on the news. This agreement is good for stocks in the short-term in terms by reducing uncertainty and taking the worst case scenario off the table. However, volatility is certain to return over the next several months as the battles over spending cuts and the debt ceiling are right around the corner in February/March. We think stocks are more attractive than bonds. High dividend stocks, MLP’s, and municipal bonds were under some pressure over the past few months on concerns that their income would be taxed at substantially higher rates if no deal had been struck, but that now looks unlikely. We continue to like these investments. We think the economy will continue to have slow, but positive growth in the U.S., and that interest rates will remain low in 2013. That is typically a pretty good environment for stocks. After all, in 2012 U.S. stocks were up approximately 16% in spite of all the drama and worry about the U.S. fiscal cliff, European debt problems, the slowdown in China, etc. We encourage investors to continue to focus on the long term, and pay less attention to the news and drama of the day. Save more, and spend less. When tax rates go up it is even more important to use our low-cost, tax efficient investment strategy. We continue to be bullish on our strategy of long-term, global, strategic asset allocation.
I welcome your thoughts, opinions, questions, comments on this. What do you think?