As debate continues swirling over the presumed-slope-that-is-mostly-a-budget-debate also known as the “Fiscal Cliff,” a few details have been trickling out regarding the state of negotiations between Republicans and Democrats. The fact finding and wrangling sheds an interesting light on how the debate is evolving—and how strong the motivation actually is to strike a deal. In a recent Financial Times article, Ken Fisher (CEO of Fisher Investments) discussed how this debate is affected by the looming 2014 midterms. Here’s some more detail on the political pressures likely driving a fiscal compromise.
I don’t think I’m breaking any real news by suggesting politicians’ primary focus is nearly always on winning the next election. And, as Ken Fisher pointed out, in the next election, several sitting Democratic senators who rode to victory on President Obama’s 2008 coattails (far longer than 2012’s version) in traditionally Republican states face reelection. It’s unlikely senators in states like Alaska and West Virginia think they can win on a record of supporting party-line legislation. They have a huge incentive to compromise. As do Republicans, who have some face-saving to do after November’s poor showing. Considering the administration is already attempting to paint them as the Fiscal GrinchTM, it would seemingly make sense for them to appear willing to compromise.
First, consider a recent letter penned by Acting IRS Commissioner Steven T. Miller addressed to Senator Orrin Hatch (R-Utah). Commissioner Miller specifically discusses the AMT patch—which amounts to roughly a third of the fiscal cliff’s scheduled tax hikes. Now, mind you, there’s an AMT-patch molehillTM nearly every year. And Congress, like clockwork, generally lets it come right down to the wire, extending it either at the last minute or, on two occasions, retroactively. This political football is kicked around annually and this year doesn’t seem to be any different.
Commissioner Miller’s letter points out exactly why it’s ridiculously unlikely AMT isn’t patched. You see, should beltway politicians not patch AMT, a tax originally designed to hit only the highest-earning Americans will somehow impact about 60 million taxpayers. That’s not a typographical error and it’s also, ironically, a bit larger than the 59,142,004 votes Republican Presidential candidate Mitt Romney received in last month’s election. Point being, the likelihood either political party wishes to anger a pool of Americans equivalent to about half the populace that voted a month ago is remote. Microscopically tiny.
Next, consider income taxes. While most attention seemingly centered on President Obama’s official initial proposal, which targeted $1.6 trillion in new tax revenue over the next 10 years, the administration also sent simultaneous signals it was perhaps willing to bend rather significantly. Folks seem to presume the Republicans’ and Democrats’ positions are set in stone, yet in reality, statements made recently give one the impression they’re more like malleable clay. At a White House press conference recently, Press Secretary Jay Carney said that the president is open to the concept of top-bracket tax rates lower than the 39.6% Clinton-era levels. Which opens the door to negotiation—37% or 38%, or other change.
And Republicans also seem willing to bend. Rep. Mike Simpson (R-Idaho) noted last week many Republicans would accept a deal involving higher taxes on the top bracket, so long as that bracket didn’t begin at $250,000 (for a married couple). He suggested $500,000 or $1 million might be more politically palatable. Obviously, there’s still a divide between Republicans and Democrats more generally, and it’s likely they won’t make much noise about the potential areas of compromise until the very end of this debate. But the reality is, whatever cliff there was seems to be slowly eroding.
There’s ample of room for compromise between these two positions on income taxes. For example, perhaps a deal involves slightly higher taxes (maybe 37.5%, for example) on couples with incomes exceeding $750,000 annually. Those higher taxes wouldn’t be great, in our view, but the scope would be far more narrow than the $250,000/39.6% threshold the current tax rates would bring.
While these factors illustrate the political motivations and signs of compromise behind two major pieces of the fiscal cliff, none of this eliminates the possibility no deal is struck. But here’s the real kicker many investors struggle with: History shows there’s no real, direct correlation between higher taxes and poor stock market results. That’s true of individual rates, capital gains and corporate taxes. Which isn’t to say I favor higher taxes—they take from the productive and give to the government, which is far less productive—but it is to put the impact in context. But either way, the likelihood politicians don’t forestall the full fiscal cliff is tiny.
So my suggestion this holiday season is to avoid the fiscal cliff—getting caught up in fiscal cliff rhetoric, that is. In all likelihood, what looms on the horizon isn’t a cliff. It’s the fiscal foot about to kick the fiscal can, rendering the fiscal cliff factually defunct.
This article constitutes the views, opinions, analyses and commentary of the author as of December 2012 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.