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FISCAL CLIFF HANGING - Dont' Jump! |
What is the Fiscal Cliff? 
Fiscal Cliff - The failed budget ceiling negotiations during the summer of 2011 caused Congress to enact a dramatic, forced spending cut of $600 billion dollars to take effect on January 1, 2013 and $1.2 trillion over 9 years. A spending cut of this size all at once will likely result in a 2-3% contraction in the US economy. Given the current growth rate of 2%, the fiscal cliff could cause two back to back quarters of negative growth resulting in a mini recession.
THE QUESTION IS: Will a lame duck Congress act to prevent this massive spending cut or "punt" until the new Congress takes office in January? What is happening with taxes in 2013?
Taxes - January 1, 2013 marks the expiration of the so-called "Bush Tax Cuts", elimination of the payroll tax holiday and addition of the new taxes on investments to pay for the health care law. Tax rates will rise for almost everyone on January 1 if Congress does not act. Here's a rundown, according to the tax firm Ernst & Young:
- The federal capital gains tax rate will rise from 15% to a maximum of 24.7%.
- The federal tax rate on dividends will rise from 15% to a maximum of 44.7%.
- The federal tax rate on interest will rise from 15% to a maximum of 44.7%.
- The payroll tax will rise from 4.2% to a maximum of 6.2%.
- The estate tax, currently applicable to estates above $5 million, will be applied to estates worth just $1 million.
THE QUESTION IS: Will such a large, sudden increase in taxes cause consumers to reduce spending - slowing the nation's economic recovery and magnifying the impact of the Fiscal Cliff?
What is the best guess regarding the outcome?
"The most likely scenario, we believe, is that Congress and the President will enact a short-term extension of the existing federal tax and spending policies-probably lasting between 3 and 12 months-to give policymakers more time to look at the big picture and decide what kind of tax and fiscal strategies they want for the long term," James Delaplane of Vanguard's government relations office said. "Ideally, that extension would be enacted before the fiscal cliff deadline arrives, but it is possible that no action will be taken until the new Congress convenes in 2013."
Here's the bottom line: There's a huge difference between the economy and the stock market. Rising tax rates that reduce federal spending might damage the economy temporarily, but that does not necessarily mean that securities prices will permanently fall. The domestic stock market has been resilient thus far. The S&P 500 Index, which represents the largest U.S. companies, has returned about 11% YTD through November 9th, 2012.
The reason the economy and stocks are different is the economy is "here and now" - do you have a job right now, what's the value of your house right now, what's the price of gasoline, food, health care and college right now? The financial markets care about the future and future is about tax reform and spending reductions which in the long run is a very good thing.
Want to learn more about what we will do if there is a big decline in the stock market and how we triumph over capital market turbulance?
For the compete article "Fiscal Cliff Hanging" click here
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