ETF Trends
ETF Trends

From the outside, it’s hard to find much evidence that Washington is getting closer to a fiscal cliff deal. Perhaps there is more going on behind the scenes than the headlines suggest, but as of today it is hard to find much evidence that the odds of a deal have risen.

As the potential for fiscal drag rises, it is worth reiterating why this is so dangerous. From my perspective, the biggest risk to the economy, and to financial markets, comes from the tax side of the equation.

To review, the fiscal cliff comprises a series of tax hikes, including: marginal tax rates, payroll taxes, capital gains, taxes on dividends, estate taxes, and a new 3.8% tax on non-wage income for high earners. In addition, without legislative action, the alternative minimum tax (AMT) will hit millions of more Americans. In aggregate, the combination of these tax increases and new taxes will equal roughly $400bn.

While the $400bn figure is normally compared to overall gross domestic product (GDP), a more relevant comparison is against disposable income, which will take a direct hit as a result of these tax increases. US Disposable Income is currently a bit below $12 trillion, which means the tax increases, should they last the full year, represent roughly 3.5% of what Americans take home on an annual basis. As I’ve argued in past, this is a very large tax hike.

Also, it will be happening at a time when income growth is already very slow. As of October, disposable income was growing at around 3.5% year-over-year, half the 50-year average. For hourly workers, the situation is even worse. Hourly wages are growing at little better than a 1% year-over-year pace. The tax hikes, particularly the jump in the payroll tax, will hit hourly workers hard.

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