Can Fiscal Cliff Negotiators At Least Agree on Taxes?

BoehnerIt looks like just two options remain for policymakers in Washington: a proactive, eleventh-hour compromise that prevents a tax hike on the majority of Americans and curbs the worst of the fiscal cliff austerity measures, or a retroactive deal that will undo the economically-draining policies set to take effect over the course of 2013. Either way, market participants are tepid and the invisible hand is idle on Monday as economists refine their gloomy forecasts for the New Year.

The fiscal cliff is a combination of draconian spending cuts and undesirable tax increases that was agreed to in the spirit of mutually assured destruction. The deal was reached the last time America’s growing deficit and debt problem was front and center in the national dialog: summer 2011. Policymakers gave themselves a ticking clock in hopes that they would find a way to work together against a common, self-imposed economic enemy. They also hoped to push back any potentially unpopular policy changes until after the 2012 elections.

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While the fiscal cliff would dramatically reduce America’s deficit and ostensibly lead to a long-term reduction in the country’s growing debt, it would also pull so much money out of the economy that many experts fear it would trigger another recession. At best, economists like Nigel Gault at IHS Global Insight are slashing GDP growth expectations under fiscal cliff policies to just 1 percent in the first quarter of the New Year. At worst, what many were hoping would be about 2 percent growth could turn into a recession.

More or less the same pair of roadblocks have been in the way since the beginning of negotiations. Republicans don’t want to see any increase in taxes, while Democrats want the rates to increase on America’s wealthiest citizens. Democrats want to protect social programs, while Republicans want substantial entitlement reform. Early hopes of a so-called “Grand Compromise” largely evaporated when Speaker of the House John Boehner’s (R-Ohio) “Plan B” proposal was torpedoed by his own party…

TaxesBoehner’s proposal was the first instance the Republican leadership conceded to a tax increase on high-income earners. The Speaker’s proposition was to let the Bush tax cuts expire for those making over $1 million per year. President Barack Obama, who was initially seeking a tax increase on those earning more than $250,000 per year, counter-offered a income level of $400,000 or more.

Boehner may have realized that some members of the GOP would never go for the President’s proposal and tried to take his plan to a vote, which failed. Since then, the President has reportedly brought a scaled-down version of his initial proposal back to the table, but it doesn’t appear that any progress has been made. Despite what appears to be the best efforts of the nation’s leaders, neither side seems able to rally the consensus of their own parties, let alone win support from across the aisle.

With time running out, economists and market participants are focusing on the few areas where the parties seem to agree. Once again, if an eleventh-hour solution is not found, then a retroactive fix could be applied to prevent the worst of the fiscal cliff measures.

Both parties agree that the Bush tax cuts should continue for the vast majority of Americans. Letting the tax cuts expire and then signing new legislation to once again lower the rates is a much more politically safe move for conservatives. Despite the negative consequences of going over the cliff and having to patch it up afterwards, it seems like this scenario is increasingly likely as the deadline approaches. At the end of the day, policymakers are engaged in political gamesmanship and not sound economics.

The payroll tax holiday that began about two years ago also seems to be staying on the chopping block. Nearly 160 million workers currently pay 4.2 percent for the Social Security tax on the first $113,700 of their annual income, but the rate could return to 6.2 percent in the New Year and would be one of the most immediately-felt effects of the cliff.

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