With the election coming up next month, we thought it might be a good time to discuss our thoughts on the looming fiscal cliff.
What’s the Fiscal Cliff?
The term “fiscal cliff” was first used by Ben Benanke to describe the imposition of large tax increases and spending cuts that are legislated to occur on January 1, 2013. If Congress fails to act, a total of $600 billion, or about 4% of GDP, will be taken out of the economy next year, almost guaranteeing a recession.
With the memory of the 2011 debt-ceiling debacle still fresh, no politician on either side of the aisle wants to have to answer to their constituents if Washington can’t get together on this somehow.
What will happen?
There are several possibilities for what could happen, including pushing the issue for another year by extending most or all of the current tax laws.
An intriguing path to resolution being discussed is to actually go over the fiscal cliff, and fix it as soon as possible by working retroactively. When the Bush-era tax cuts expire in January, tax rates return to Clinton-era levels, and Republicans would then be negotiating to reduce taxes rather than being pressured to raise them. The Democrats would certainly welcome this but they will also stick to their call for raising taxes on the wealthy.
Both sides would have some common ground in that they want to avoid the dramatic cuts to military and non-military spending. Either way the calls for action will get louder and louder as soon as the election is over. We believe that it is likely a compromise will happen.
What does this mean for me?
While this uncertainty makes it difficult to do tax planning, it doesn’t change our investment strategy. We consider fiscal policy as part of our research process, but we don’t believe in making dramatic shifts in our allocation strategy based on something that may not happen.
Investors that move into cash and bonds (as a bet that there will be no compromise) will have a tough decision as to when to get back into stocks if Congress and the White House do indeed find some common ground and markets move higher as a result.
Our disciplined process includes gradually reducing stocks as prices move higher, which puts us in a position to capitalize on a market sell-off. Our investment philosophy/strategy is focused on the long-term with an understanding of both macro economic conditions and client specific needs. No matter what happens with the fiscal cliff, we are prepared.
Photo credit: Aaron D. Feen
