No sooner was the US Presidential election done and dusted than attention turned to the looming ?fiscal cliff?. Over in the US it is big news, with the financial
No sooner was the US Presidential election done and dusted than attention turned to the looming ?fiscal cliff?.
Over in the US it is big news, with the financial markets and commentators following the story closely. It is also causing concern here in Europe, since damage to the US economy could have worldwide implications. Stockmarkets do not like uncertainty, so there may be some volatility as the political debates progress. Having said that, markets have known about this 31st December deadline for two years – but now it is just a month away.
What is the fiscal cliff?
The term was coined by Federal Reserve Bank (Fed) Chairman Ben Bernanke to describe the coincidental impacts of:
1. The scheduled increase in tax rates, partly related to the expiration of the Bush-era tax rates;
2. Spending cuts tied to the automatic $1.2 trillion in cuts over 10 years.
The 2013 cuts will amount to around ?100bn, with the main areas targeted being defence, medicare and unemployment benefits.
At the same time there will be ?380 billion of tax rises; ?110 billion of which from the sunset of the Bush era rates.
In the early 2000s President Bush introduced tax cuts, including lowering the marginal tax rates for individuals, particularly higher earners. He intended this to be a permanent reform, but had to compromise and make them temporary. They should have expired in 2010, but President Obama and Congress extended them for two years because the economy was too weak to handle tax rises.
One of the resolutions of August 2011?s tense debt ceiling negotiations called for the creation of the Joint Select Committee on Deficit Reduction, with equal representation from both Democrat and Republican parties. It was charged with forming a plan by November 2011 to find $900 billion in federal spending cuts over 10 years. If it failed to reach an agreement, drastic cuts of $1.2 trillion would be implemented over 10 years. The result? It failed.
Can this be resolved?
Most analysts believe that these issues will be addressed, though it will probably be tough going along the way. With the unemployment rate near 8% and the US economy growing at around 2%, it is hard to imagine that elected officials from either side will allow these issues to move completely over the fiscal cliff.
The Republicans and Democrats have promised to work together to reach an agreement. Congressional leaders of both parties have already had a meeting with President Obama.
President Obama was clear during his election campaign that he wants to raise tax rates on individuals earning over $250,000, while letting the lower rates remain at 2012 levels. The Republican Speaker of the House of Representatives, Speaker Boehner, has since stated publicly that he will consider increased revenues if it is part of lowering marginal rates and broadening the base.
President Obama and Speaker Boehner reportedly came very close to a ?grand bargain? in summer 2010 on these same topics, so there is some type of blueprint to work from. However the last meaningful tax reform in the US was back in 1986, and that took almost a year to work out.
It is hard to imagine that the US will introduce any meaningful tax reform between now and 2013, but it may take steps forward. There could be agreement to move the marginal rates now and look at tax reform next year. Changes to the tax rates could happen early 2013, and not necessarily by end 2012.
There is no denying the spending cuts are tough. Again there have been previous discussions that could aid today?s negotiations. It is likely that in the end there will be less than $100 billion of cuts in 2013 – but still significant cuts – and both sides could agree on reforms for the coming years.
An agreement that changes the trajectory of the growth in the US national deficit, and shows real commitment to addressing fiscal imbalances, could be very empowering for the US and global economies. With politicians from both parties needing to avoid the fiscal cliff, we expect some sort of agreement to be formed. However we can also expect negotiations to be fraught, as they were in summer 2011.
From an investment point of view, the December negotiations may lead to stockmarket volatility, as happened with the debt ceiling debate last year. Short-term declines should not however detract from the long-term potential of stockmarket investing.
For advice on investing in the current climate speak to a wealth management advisory firm like Blevins Franks. Blevins Franks specialises in providing personalised wealth management advice to British expatriates.
22nd November 2012
The tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual should take personalised advice.