Guest post written by Hillary Elder, Team Leader, Taxable Money Fund Strategies, HighMark Capital Management, Inc.
While the fiscal cliff deal approved by both the Senate and the House of Congress in the wee hours of January 1, 2013 does avert most of the previously scheduled tax increases, it does not include any provision to raise the debt ceiling, and it defers the scheduled spending cuts for two months. Given the confrontational tone of the negotiations over the last two weeks of 2012, the upcoming negotiation over these key issues could lead to a shutdown of the Federal government by late February or early March.
The bruising 2011 battle to raise the debt limit was instrumental in Standard & Poor’s decision to lower the long-term debt rating of the United States. Moody’s Investors’ Service indicated back then that they needed to see a stabilization of the ratio of federal debt to GDP, as well as a long-term plan to reduce this ratio.
The temporary 2% reduction in the payroll tax rate paid by employees was not extended, which will increase taxes by roughly $120 billion per year, for about a 1% reduction in personal incomes. This impacts all workers’ incomes. Lawmakers settled on higher tax rates (39.6%) for income in excess of $400,000 for individuals ($450,000 for couples), up from the current 35%. This impacts the top 1% of incomes.
Revenue will also be raised via limits on personal tax exemptions and deductions affecting individuals earning over $250,000 (families – $300,000).
The “deal” also permanently fixes the inflation indexing of the Alternative Minimum Tax, raises doctor’s Medicare payment rates and renews extended unemployment benefits. No change was made to the new taxes to investment income under the health care law that takes effect in 2013.
Congressional Budget Office estimates put the overall negative impact on annual GDP at approximately 1%, with much of that impact being felt in the first quarter of this year.
With a little more certainty on taxation, we look for businesses to resume capital spending enabling the US to escape recession. We expect GDP to increase by 2.0% in 2013.
Unfortunately, we are not as optimistic about the prospect of meaningful action to address the medium-term budget issues, anticipating that the U.S. may suffer another credit rating downgrade this year. Given the markets’ reaction in 2011, this would likely not raise the cost of financing the national debt, impact our investment strategy, nor weaken the dollar, as the U.S. remains a desirable investment destination.