On the first day of 2013 — if no action is taken — we are facing big changes in both tax and government spending policy.
This is the fiscal cliff.
The fact that uncertainty of this magnitude exists is the definition of silly public policy. Yet, despite the expected political theatrics, I believe investors have little to fear on New Year's Eve. The consequences of inaction are simply too severe for either party.
Some background on the fiscal cliff might be helpful to explain my calm. Back in 2001 and again in 2003, various tax cuts were enacted.
To get the necessary votes, Congress used legislative tactics that required the tax cuts to expire at the end of 2010. Back then, it all seemed like a long way off.
Right before the end of 2010, President Obama and Congress agreed to extend the current tax law for another two years.
Both sides agreed to renew the fight after the 2012 election.
Their compromise was very poorly designed.
Their deal purposely added fuel to the fire by forcing large, automatic and immediate cuts in 2013 and beyond to both the defense budget and to a wide-range of domestic programs. As if they needed more incentive to develop a more permanent and predictable fiscal policy!
With no action taken, the looming changes to tax policy are dramatic.
For example, the tax changes slated for the start of 2013 include increases in each and every tax bracket, the elimination of the payroll tax cut currently enjoyed — in many cases, needed — by every worker, a much higher tax on dividend income, a boost in the long-term capital gains tax and a huge increase in the estate tax.
In addition, with the gradual implementation of the new health care law, 2013 also happens to be the year that new taxes affect higher-income taxpayers.
The combination of these tax hikes and the automatic spending cuts would result in a significant hit to economic activity. Given the very weak economy, political inaction would certainly push us into a recession and lost jobs.
For this simple reason, I strongly believe the cliff will be avoided. Even the most partisan of our politicians understand the stakes.
Unfortunately, the path to a final compromise is likely to at first resemble an amateur circus act.
In my view, the outgoing Congress and President Obama will slowly inch their way to Jan. 1 before a very short-term deal is finally struck.
Investors can afford to ignore the opening act. Soon after, a new and more predictable set of policies will emerge, no matter who is elected.
That's the only part of the show worth watching.
Jason P. Tank is a chartered financial analyst and co-owner of Front Street Investment Management LLC, a local fee-only investment advisory firm. He encourages questions, comments and suggestions for future columns. He can be reached at 947-3775, email@example.com or visit www.frontstreet.com.