With Barack Obama’s victory, one of the sources of market uncertainty—the outcome of the election—no longer hovers like a gray cloud over the investment landscape.
However, three other sources of uncertainty still remain, each of which is likely to have a significant impact on the direction of financial markets: whether the president and a lame-duck Congress can resolve or postpone the “fiscal cliff” before Congress is scheduled to adjourn on December 14; whether Washington lawmakers can raise the federal debt ceiling in early 2013 without triggering a financial crisis; and whether President Obama can do in 2013 what he failed to do during his first term, that is successfully negotiate a long-term budget agreement with Congress that combines reductions in the growth of entitlement spending with increases in federal tax revenue to reduce the federal deficit over the next decade.
A large source of uncertainty for the past months has been that investors do not know what federal tax rates will be in 2013. In the coming weeks, that, too, will come into focus. Under current law, all the Bush tax cuts on earned and investment income are set to expire at the end of this year.
In his 2012 budget to Congress, President Obama proposed extending existing tax rates for household income up to $250,000 and allowing rates to increase for families making more than $250,000. Unless the president and Congress reach a compromise or agree to delay increases in existing rates until a comprehensive budget agreement can be negotiated in 2013, the top tax rate on ordinary income would revert back to 39.6%. Because President Obama increased Medicare payroll taxes by .9% and passed a tax of 3.8% on investment income to finance health insurance reform, families with adjusted gross income above $250,000 are scheduled to face a top rate of 40.5% on wages, 43.4% on taxable interest and dividend income and 23.8% on capital gains.1
During the last days of the campaign, the White House indicated that it would veto any “fiscal cliff” resolution that failed to raise income tax rates for the wealthiest Americans.2 This declaration makes it doubtful whether a compromise can be reached with the Republican-controlled House, many of whose members have, in effect, said, “Read my lips,” by signing pledges not to raise taxes. Should a stalemate develop that prevents a resolution, taxes would go up for all Americans: $800 billion over 10 years for the top two income brackets; $3.2 trillion over 10 years for all other tax payers.