Fiscal Cliff-What’s All the Hubbub?
You’re probably hearing a lot about the Fiscal Cliff, and may be wondering
• What does it really mean?
• What are the implications?
• What can, or should, I do?
In order to answer these questions, I have a slightly longer than usual video this week (about 10 minutes), but one of the best ones I’ve done in a while (if I do say so myself).
This is a very timely subect, and you’ll be hearing about the Fiscal Cliff in all the media for the next month or so. Now is your chance to be as informed as possible, and take action if necessary.
Click on the video
Good Morning! Mike Brady with Generosity Wealth Management speaking to you from Boulder Colorado. Hopefully you had a very nice Thanksgiving weekend.
Today, I want to talk about the fiscal cliff. Perhaps you have read or heard about the fiscal cliff and have wondered, “what the heck is it?” I mean they seem to talk about it like it is so obvious what the implications are and I thought I would take a step back with you and talk about the origin, kind of what the fiscal cliff is, but also what are some things that we can do between now and the end of the year and also what the implications may be for the stock market.
Let’s start off with the beginning. Back in 2001, there was a pretty much across the board reduction in income taxes from the lower rates to the higher rates about 3% give or take. At that time there were also child credit increases, which was a good thing. This was all renewed in 2010. It was supposed to expire in 2010. At that time the Obama administration with the Democrat Senate and House of Representatives extended it for another two years and that two years is coming up. So when it is described as the Bush era tax cuts, at this point really I would say it is the Bush and the Obama because really both sides of the isle have either started it or extended it. And so, at this point now, both sides of the isle want it extended as well, but they are disagreeing about how to extend it and to whom it is extended and which parts of it.
What does this really mean? Well, from an income tax point of view, pretty much across the board from the lower income tax rate all the way up to the higher ones; it is going to go up about 3%. I am going to throw up a graph there on the video and you’re going to kind of see how before and after it can go up. In addition capital gains are going to go from, at the very lowest it is going to go from 0 – 15 or from 15 – 20% on capital gains. Dividends are going to go from 15% all the way up to whatever your marginal tax bracket is, which could be 39.6 if you are in the very highest. Your payroll tax, two years ago, in addition to extending the tax cut, they lowered the FICA tax that is charged to the employees. It went from 6.2% down to 4.2%. Well that would be reversed. So 4.2%, so basically an extra 2% tax for those that are W-2 employees, well all people who pay FICA tax, so whether you are self-employed or a W-2. Also from an estate tax point of view, right now estate taxes are 35% to the amount in excess of 5.12 million, the amount that is excluded from estate taxes. If this isn’t resolved, in January it will be the amount over 1 million dollars per person, will be at 55%. It will go from 5.12 at 35 to 1 million dollars at 55%. A million sounds like an awful lot of money but once you start adding up life insurance and your house and your retirement account, it is very easy and quick to get over a million dollars. So this is a huge impact for a significant number of people.
You might ask yourself, who cares about all taxes, whether or not they are higher or lower, etc. And the argument, the reason why this is such a big deal is when taxes are raised, that is usually a decrease in production of some amount and so the question is although, for each dollar there is more of a tax in my example, right now we are talking about 3%, there might be less productivity in order to charge it on, so that your net after-tax is actually less to the federal reserve, to the federal treasury than you had before. Both sides of the isle ultimately want the tax rates to be lower because they believe that it will hinder the growth that has been happening most recently and harm the recovery that we’re seeing some legs under right now. So both sides want it. The question is to whom is the extension really going to be applied to. Is it going to be applied since the reduction was across the board, is the reduction across the board going to stay or are some at the very highest going to allow to be lapsed and so their rates go up when everybody else gets to stay the same?
That right there is where a lot of the compromise is going to happen in the next month or so. Now let’s talk about what could happen. I mean, essentially, number one, they could let it lapse. I don’t think that’s very likely. Both sides want something to happen. Congress has a tendency to work well when the pressure is on, when the public and when the media is putting so much of a spotlight on it. They could extend some but not others. That is absolutely possible. As a matter of fact, I would even argue that that is more likely, either some to all is going to be extended. Of a lack of the overhaul, the whole tax mode and that’s great, wonderful thinking, but that’s not going to happen.
What does this mean for the markets? Remember about a year and a half ago, the AAA rating of the US government was downgraded. At that time there was a huge decline in August and September and a little bit into October of 2011. There was a huge deal by S&P, or was it Moody’s? I can’t remember. One of the two, basically saying that they felt that the deficit was getting out of control and that we didn’t have the political will in order to solve it. This would be another further confirmation that that assessment a year and a half ago was actually true. I think that that would be a very bad thing if we are not able to get this resolved.
I still believe and you’ve heard me the last nine, 10 months or so, feeling strong about the underlying fundamentals of the private sector of the corporations, etc. Although we have a kind of a jobless recovery, the efficiency and the profitability of some of the corporations are great and I am feeling very optimistic and positive about that. This is a huge drain on the full economy of the United States and, of course, on the world because we are the world’s largest economy. I do believe that the market would go down and there is going to be a reaction to it. The question is how long that would be, whether that would be temporary or whether that would be permanent. If it does go down, I believe that it would be a temporary thing because the underlying fundamentals I still feel strong about.
A year and a half ago, let’s not forget, that the markets went down in August in September and they actually had a very nice rally after that. We got rid of some of the people who got scared. Those of us that were still invested in October, in general, in an unmanaged stock market index, did very well in the six months following. I think that this would be potentially a temporary downturn as well. We still have a whole month before now and then and it’s been hard to try to guess what the federal government is going to do and our particular politicians.
What can you do between now and then if you believe that tax rates are going to go up and it is not going to get resolved, basically you try to do more taxation in this year. You can sell those assets that have capital gains. You could reposition your assets, like for dividend paying stock, they can go over to maybe reposition in IRAs and some things of that nature. Or you are looking at bond issues, maybe it would make sense to go into municipals or tax-frees or something that is not fully taxable. There are a number of different things that you can do. If this does occur and what can we do in 2013? Absolutely we should consider the estate tax. At that point I will be talking with many of year to ensure that you have your estate planning and your estate planning attorney have really reviewed your particular situation as it relates to estate tax with various types of trusts and other things that you can do to try to minimize the very high estate tax that you might suddenly find yourself.
Anyway, that is the fiscal cliff in a few minutes. A few minutes, I think, probably turned into an even longer time, maybe ten minutes, which is a longer video than normal, but this is your summary.
Generosity Wealth Management
Hopefully I can help you out. If you are one of my clients, of course, I have an ongoing conversation with you. If you are not one of my clients and want to give me a call, go ahead and do so at 303-747-6455. My pleasure talking to you. You have a great day. Thanks, bye bye.