President Barack Obama's determination to avoid being branded the man who allowed the nation to fall off the fiscal cliff could be good news for financial advisers and their wealthy clients, who are facing dramatic tax hikes next year if no new legislation is passed.
Although the president has so far insisted on raising taxes on wealthier Americans as stubbornly as the Republicans have opposed it, now that he is re-elected, he may be more inclined to compromise. If he doesn't, he could go down in history — for all the wrong reasons.
“The second terms for presidents are about building a legacy, and if [the fiscal cliff situation] isn't resolved in some form, it won't be the legacy he wants,” said Tim Steffen, director of financial planning at Robert W. Baird & Co. Inc.
One thing is for sure: With the raft of scheduled tax increases and spending cuts just six weeks away from taking effect, the president's second term could get off to a very dismal start.
BATTLE AGAINST TIME
The fiscal cliff was barely addressed by the candidates during the campaign, but it is now front and center for the president and the lame-duck session of Congress, which starts this week.
The idea of legislating a $600 billion-plus package of austerity measures that would automatically take effect seemed good 18 months ago when Congress last approved an increase to the debt ceiling. After all, what better motivation to strike a reasonable deal on the debt than having a monstrous outcome looming in the future if you don't?
The future is now, however, and apparently, monstrous outcomes don't scare today's partisan politicians.
The spending side of the fiscal cliff equation would involve $109 billion in cuts next year split equally between defense and non-defense budgets. The tax increases would run the gamut: Marginal tax rates would revert to higher, pre-Bush-era levels; tax rates on capital gains would rise to 20%, from 15%, and from 15% to potentially as high as 39.6% on dividends; the estate tax rate would rise to 55%, from 35%, while the exemption would fall to $1 million, from $5.12 million.
All in, elements of the package passed in the Budget Control Act in 2011 and other expiring tax cuts, including the 2% payroll tax cut, would pull nearly $500 billion from the private sector of the economy next year.
“It's unthinkable that the politicians will let this happen,” said Allen Sinai, chief global economist with Decision Economics Inc. “It's crucial that they postpone the tax increases.”
The Congressional Budget Office estimates that the tax increases and spending cuts will reduce GDP between 3.5% and 4% next year and likely tip the already weak economy into a recession in the first six months. It also could result in negative growth for the entire year, depending on the reactions of business leaders and consumers.
ANOTHER RECESSION?
“I don't think going over the cliff would result in a deep recession, but that's only because it's hard to get hurt falling out of the basement,” said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. Inc. “It will, however, cause a significant decline in economic activity across the economy.”
Based on the virtual stalemate between the two political parties in the past two years, the prospects for resolving the issue might seem bleak. The cast of characters in Washington is essentially un-changed from a week ago, and both sides can and have claimed that the election confirmed their mandates.
So what spurs them to meet somewhere in the middle now?
“The difference now is that we know nothing has changed because of the election, and maybe that gives them more incentive to accomplish something,” Mr. Steffen said.
Financial advisers, like most other Americans, expect that the politicians simply won't let this happen. Few think that the president and lame-duck Congress can hammer out any substantial deal before year-end, but most expect an agreement at least to push the deadline out again and leave the issue to the new Congress.
“People don't get hit by buses when they see them coming,” said Ric Edelman, president of The Edelman Financial Group. “We think something is going to get done.”
Tom Muldowney, managing director of Savant Capital Management, expects an extension of possibly six months but worries that further delays in reducing the more than $1 trillion in deficits the federal government has racked up in the past four years will soon cause serious problems.
“If we continue to neglect this and keep spending as we are, we'll end up like Greece, and that's the real fiscal cliff,” he said.
How long of an extension should the lame-duck session grant to the new Congress?
Greg Olsen, an adviser with Lenox Advisors LLC, suggested that a longer period — even two years — would give much-needed clarity to consumers and a business community still reluctant to spend money, given the economic uncertainty.
“This is no way to run a business or to plan your finances,” Mr. Olsen said. “People shouldn't be scrambling to draft estate plans at the last minute.”
A lengthy extension wouldn't resolve the uncertainty and would simply give politicians another opportunity to avoid the issue, said Chad Stone, chief economist for the Center on Budget and Policy Priorities.
“Maybe we need to go over the cliff for people to get serious about this. If we do, the politicians would have to go in and reverse it,” he said.
Most political analysts don't think that the two parties are willing to run that risk. As to the nature of any bargain that would establish a credible deficit reduction plan, tax rate increases on the wealthy remain the chief obstacle.
In a statement the day after the election, House Majority Leader John Boehner signaled that the Republicans will continue to oppose rate hikes on anyone, but he did provide some hope that there is room for compromise.
“Because the American people expect us to find common ground, we are willing to accept some additional revenues via tax reform,” he said.
DEDUCTIONS, LOOPHOLES
That Romneyesque position will set off a lobbying free-for-all as interest groups fight to preserve deductions and loopholes. The idea was unacceptable to Mr. Obama during his campaign, but without another election to worry about, he may now be more open to the idea.
The president's first post-election address on the subject last Friday suggested he is maintaining his current position. “We need to reduce the deficit in a balanced and responsible way ... [and] that means asking wealthy Americans to pay a little more.”
Mr. Obama also challenged the GOP to extend middle-class tax cuts and leave the other issues for later.
“I'm not wedded to every detail of my plan,” he said. “I'm open to compromise, but I refuse to accept any approach that isn't balanced.”
Leaders of both parties will discuss the matter at the White House this week.
George Michaels, chief executive of consulting firm G2 FinTech, thinks the chances of a grand bargain are better with the president's re-election because Mr. Obama no longer will have to cater as much to his base constituency.
“He may upset a lot of people on the left, but I think the president wants to leave a positive legacy, and unlike 2008, he has to work with the Republicans to achieve that,” Mr. Michaels said.
aosterland@investmentnews.com Twitter: @aoreport
