Dear Clients and Friends,
You might have missed it, with the ball dropping in Times Square, champagne bottles popping and fireworks exploding, but the U.S. flew off the so-called “fiscal cliff” at 12:01 AM on New Year’s Day. The term “fiscal cliff” has been used by politicians and the media to describe the automatic spending cuts and expiration of tax breaks that were set to occur at the beginning of 2013. It was widely accepted that should these spending cuts and increased taxes take effect it would drag down our economy to a near-certain recession. It was also a widely recognized problem for well over a year, and everyone knew that the only way to avoid this calamity was to have our elected representatives in Congress work together and do something that has become increasingly difficult in our national politics: compromise. And, much to our disappointment, they were unable to reach a compromise before the deadline.
The financial media had latched on to the idea of a steep cliff and our economy going over it like Thelma and Louise in their blue convertible. In reality, it would not have been so much a cliff as a slope, since government spending would be cut throughout the year and wage earners would not have a huge chunk of their salary taken out of their first paycheck. Instead, wages would have been taxed at a higher rate and more would have been withheld for taxes going forward. Still, not solving the issue would have proved to be a large drag on our economy.
Then, to the surprise of some of us, Congress did get together on New Year’s Day and came to an agreement about how to fix the problem, at least temporarily. Like any good compromise, the deal they came up with did not please anyone completely and did not do everything that leaders of both political parties had set out to do, but it averted a crisis for now. Under the American Taxpayer Relief Act of 2012, taxes will likely be higher in 2013 than they were in 2012 for most wage earners, and high-income taxpayers will be subject to higher rates than before and will have fewer deductions. It did make some tax policy permanent, such as the so-called AMT patch, but it left other important questions up in the air. So, rather than driving off a fiscal cliff, we went over a one-day fiscal pothole and then Congress was able to keep the car going. I know a college professor who commented that her students would not receive credit for work turned in late, and it remains to be seen whether voters feel our public servants deserve credit for this performance or not, but for now the panic has died down.
Unfortunately, that is not the whole story. The Act did not address the structural problems in our tax system, which many hoped would be totally restructured in this debate. It did not address our national debt limit, which will likely be reached sometime this quarter and will require another heated debate in Congress and in the media. Congress did not come to agreement about mandatory spending cuts, and the Act pushed that decision to later in the first quarter, essentially kicking the proverbial can down the road.
As a result of all this, we are headed for another “Fiscal Storm,” likely coming sometime around March of this year. There will likely be many lengthy speeches from Congress and the President, an infinite number of news stories about the problems coming and the different scenarios that might play out, and continued volatility in the financial markets. It is easy to imagine another 11th hour showdown, with another unsatisfying compromise agreed upon a day late. Whether this scenario occurs or not, there is sure to be another crisis, serious or exaggerated, soon afterward. It would be ideal if the country could come together and build a new and well thought-out fiscal and economic road, but the odds are good that we will continue running into potholes. The important thing is to see through the “noise” of whatever is in the news and determine if the current crisis is really important, or just another bump that someone needs to write a story about.
We encourage you to prepare yourself emotionally for this next wave of uncertainty, and to be sure to contact us if you feel we should review your accounts. We cannot predict whether the markets will be higher or lower in a week or a year from now, but what we can do is make sure that your investments are diversified and have a level of risk that is comfortable for you. Despite all of our challenges, fiscal and otherwise, and despite our collective disillusionment with our political process, the United States of America is still a great country, and we believe our future looks very bright. We look forward to sharing that future with you.
Theodore Haley, CFP® AIF®