Senate "Cliff" Bill Unlikely To Pass Houses

Senate "Cliff" Bill Unlikely To Pass House

By Lance Roberts of Streettalk Live

January 1, 2013

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At the end of November I wrote "The Definition Of Insanity: Republicans", where in I detailed a reasonable negotiation between the Democrats and Republicans on settling the "Fiscal Cliff" issue. Well, late last night, the Senate passed a bill with 89 votes that only went part of the way.

Here are the details of the bill from the Washington Post:

Tax rates will permanently rise to Clinton-era levels for families with income above $450,000 and individuals above $400,000. All income below the threshold will permanently be taxed at Bush-era rates.

The tax on capital gains and dividends will be permanently set at 20 percent for those with income above the $450,000/$400,000 threshold. It will remain at 15 percent for everyone else. (Clinton-era rates were 20 percent for capital gains and taxed dividends as ordinary income, with a top rate of 39.6 percent.)

The estate tax will be set at 40 percent for those at the $450,000/$400,000 threshold, with a $5 million exemption. That threshold will be indexed to inflation, as a concession to Republicans and some Democrats in rural areas like Sen. Max Baucus (D-Mt.).

The sequester will be delayed for two months. Half of the delay will be offset by discretionary cuts, split between defense and non-defense. The other half will be offset by revenue raised by the voluntary transfer of traditional IRAs to Roth IRAs, which would tax retirement savings when they're moved over.

The pay freeze on members of Congress, which Obama had lifted this week, will be re-imposed.

The 2009 expansion of tax breaks for low-income Americans: the Earned Income Tax Credit, the Child Tax Credit, and the American Opportunity Tax Credit will be extended for five years.

The Alternative Minimum Tax will be permanently patched to avoid raising taxes on the middle-class.

The deal will not address the debt-ceiling, and the payroll tax holiday will be allowed to expire.

Two limits on tax exemptions and deductions for higher-income Americans will be reimposed: Personal Exemption Phaseout (PEP) will be set at $250,000 and the itemized deduction limitation (Pease) kicks in at $300,000.

The full package of temporary business tax breaks — benefiting everything from R&D and wind energy to race-car track owners — will be extended for another year.

Scheduled cuts to doctors under Medicare would be avoided for a year through spending cuts that haven't been specified.

Federal unemployment insurance will be extended for another year, benefiting those unemployed for longer than 26 weeks. This $30 billion provision won't be offset.

A nine-month farm bill fix will be attached to the deal, Sen. Debbie Stabenow told reporters, averting the newly dubbed milk cliff.

There are two big issues with the current bill that will keep it from passing in the House without substantial amendments:

The cuts to spending are too small ($15 billion) relative to $620 billion in tax hikes over the next decade, and;

There are no measures to control future spending.

In its current form the deficit will increase in 2013 as higher taxes lead to lower economic growth. It is not just higher taxes on the "rich" but also on the middle class as the payroll tax cut expires leading to a 2% increase in taxes. The direct cost of the increase in payroll taxes will be roughly $125 billion equating to a drag of 1% on GDP alone. Slower economic growth in 2013, combined with no spending reforms, will lead to an expansion of the deficit in 2013. This is a point that is not lost on the Republican controlled House.

Furthermore, while the Republican party may have lost the election, the duly elected representatives in the House would like to keep their seats come the next elections in 2014. If they give way to a bill that once again caves to the demands of the White House, as they did in 2011, it is likely they will be replaced by their constituents.

My expectation is that in the days ahead that we will see this current bill substantially revised, passed by the House and sent back to the Senate for a vote. The back and forth is likely to weigh on the markets in the short term as the debate ensues but in the end we will likely end up not to far from where we are now - higher taxes and little spending reform. The chart below details the rough estimate of what would happen at the $250,000 threshold but the change to $400,000 should not change the analysis too much.

The good news is that the lack of spending cuts will work to offset some of the impact from "fiscal cliff" on the economy. However, it will also mean that the Fed will likely continue to be engaged in QE programs to offset the economic drag caused by increasing debt and deficit levels. While an economy running at roughly 2% for the next decade is not the "end of the world" it is also not a rate of growth that will absorb population increases or create the type of employment, and wage, growth needed to return the country back to economic health.

At some point the President, either the current or the next, will have to lead. There will come a time when our elected leaders will ultimately have to start a national conversation about the tough choices that have to be made to spending, entitlements and tax reform. It will be a conversation with America about the things that they really do not want to hear. Yet, it is in this leadership, that we can begin to face the inevitable decisions that must be made to return the country back towards a path of organic economic growth and prosperity.

Originally posted at Lance's blog: streettalklive

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