Who else is ready to stop hearing about the fiscal cliff?
The Most Obnoxious and Self-Imposed Crisis of 2012 is just about over, as both houses of Congress and the president agreed on a last-minute deal to avoid the fiscal cliff.
You can read the whole thing here, but here are the important highlights.
- Marginal tax rates on those earning $400,000 and up, or $450,000 between married couples, will revert to the Clinton-era rates of 39.6%. The changes are permanent, meaning there is no automatic expiration date (though Congress and the president can change the tax code at any time).
- All income below $400,000/$450,000 will be permanently set at the Bush-era income tax rates.
- Taxes on capital gains and dividends will rise from 15% to 20% for those with incomes above $400,000/$450,000. Rates are permanently set at the prior 15% for most other income levels (some low-income brackets are exempt from taxes on capital gains and dividends).
- The payroll tax cut in place since 2010 will expire. This will raise taxes by about $1,000 for a typical middle-class family. Payroll taxes are levied on the first $113,700 in income.
- The estate tax will be set at 40%, with a $5 million exemption indexed to inflation (meaning it will adjust upward every year). According to a report by Bank of America's US Trust, there were about 850,000 U.S. households worth more than $5 million at the end of 2011, or roughly 0.7% of all households.
- The Earned Income Tax credit and the Child Tax Credit get a five-year extension.
- The alternative minimum tax gets a permanent inflation patch, preventing it from hitting more taxpayers than it was designed for.
- In aggregate, the tax changes raise tax revenue by $600 billion over the next decade. The economy should produce something close to $220 trillion in GDP during that time, so the tax hikes total less than a third of a percent of GDP.
- The automatic spending sequester mandated by last summer's debt-ceiling debate will be delayed for two months, likely so Congress and the president can agree on a more bearable way to reduce spending. The sequester was designed to be hated by both parties in order to incentivize a deal. Alas, the incentive wasn't enough, so we chose the next best option: kicking the can down the road again.
- Cuts to Medicare payments made to doctors will be delayed another year. This so-called "doc fix" has been in place since 1998.
- Unemployment insurance for those receiving benefits for more than 26 weeks gets a one-year extension. Benefits for the long-term unemployed had been scheduled to expire yesterday.
The most disappointing part of the deal is that it doesn't do anything to address the self-imposed federal debt ceiling, which was hit earlier this week. The Treasury is taking emergency actions like forgoing payments to federal retirement funds in order to keep the government's bills paid, but it can only do so for about two months. After that the U.S. will either voluntarily default on its debt or (almost definitely) raise the limit, as has been done on average every nine months since 1945. The fiscal-cliff debates were a perfect time to agree to raise the debt limit as part of a broader budget deal. With that option gone, Congress and the president now have to undertake another round of playing chicken with the nation's finances in the coming weeks, which means more opportunity to show global financial markets how utterly reckless our elected leaders can be.
The deal is less ambitious than either party envisioned even a week ago. Bringing negotiations down to the last day possible guaranteed that result. And as I wrote last week, we probably won't see any serious long-term budget reform until markets protest and interest rates rise. There is little incentive to reduce the debt when borrowing costs are below the rate of inflation. Until that changes, expect more tiny, short-term budget deals like this one.
Most of this is a sideshow that shouldn't affect how you invest. Beyond a few daily swings, markets showed little reaction to the fiscal-cliff debates during the last few weeks, because it has always been likely that a deal would be reached, even if the timing and details were unknown. The economy is in increasingly better shape, plenty of stocks trade for good valuations, and those who think in decades, rather than weeks or months, have as much to look forward to as they ever have. If you find yourself tempted to tweak your portfolio based on fiscal-cliff headlines, stop. Dysfunctional politics is no excuse for dysfunctional investing.
What do you think about the deal? Sound off below.