Taxing Times: Super Committee or NOT?
As of the time of writing, Congress has returned to Washington DC after a month-long recess. With the resumption of legislative matters, the bipartisan committee charged with recommending spending cuts amounting to $1.5 trillion over ten years will begin negotiations.
The committee’s recommendation is due to Congress by November 23rd with projected approval by December 23rd.1 If common areas of agreement for $1.5 trillion are not forthcoming, automatic cuts (aka sequester) of $1.2 trillion will be triggered beginning January 2012. Potential automatic cuts to both Defense and Health Care should and could drive meaningful compromise.
To put these figures into perspective, last year’s deficit was nearly $1.3 trillion. 2011 tax revenues are around 15% of GDP while Federal spending is approximately 24% of GDP.2 Unfortunately, the past fate of similar committees (see below) show that reasonable voices have not been heeded so far.
Members of the Joint Select Committee on Deficit Reduction are:
Perusing these names, we wonder:
1. How is this group different from its predecessors? Since December 2010 there have been three previous attempts to achieve the same goals of reducing long-term spending rates, forging a credible plan to reduce the debt and dealing with tax reform.
First, President Obama’s appointed bipartisan committee to cut the deficit presented “The Moment of Truth” which could not even garner enough support among its members.
Next, the bipartisan “Gang of Six” lawmakers could not agree and became a “Gang of Five.”
Most recently in August, Obama and House Leader John Beohner tried to forge a grand agreement which would simultaneously raise the debt ceiling, cut spending and raise tax revenues. Their efforts failed and contributed to Standard & Poor’s decision to downgrade U.S. debt and put the country on negative credit watch.
2. Can we expect progress on the issues of reducing the deficit, long-term debt and revamping the tax code? At a glance, meaningful agreement does not look promising. We note that each Republican on the committee has signed a “Taxpayer Protection Pledge” affirming opposition to all efforts to increase tax rates with an additional promise to oppose reductions or eliminations of deductions unless matched by spending reductions.3
3. What about the individual members’ experience? None of the Democratic Committee members have presided on previous committees. However, Jeb Hensarling, a Tea Party favorite, who was a member of last year’s National Commission on Fiscal Responsibility and Reform, is already well versed on the issues and a vocal opponent to Obama’s Health Care Bill. This fact alone increases the potential for future contention.
Could the Super Committee exceed expectations?
We expect the new committee to tackle the same well worn controversies that bedeviled previous committees. Current goals for spending reductions are set far lower than the $4 trillion targeted in “The Moment of Truth”4 or the $3.7 trillion in spending reductions proposed by the “Gang of Six” or Obama and Boehner during the debt ceiling debate. While Standard & Poor’s called for $4 trillion in cuts, a maximum of $1.5 trillion looks likely.
Possibility of moving toward the center?
Current opinion polls show a 13% approval rate for Congress.5 Fear of losing one’s job may be a powerful motivator (as of this writing, Congress is not subject to performance reviews like most employees). Post recess, some of Obama’s most aggressive critics are sounding a bit more conciliatory and business leaders are calling for a more balanced approach.6
What about your portfolio?
For investors, we expect potential for more volatility given the fiscal and macroeconomic issues in Washington and in Europe. Equity market volatility, as measured by the VIX index7, was almost 40% higher in July and August (when the debt ceiling debate dominated the news) versus the rest of the year to date8. Troubling news abroad in addition to the politicking in the U.S. are the primary culprits. Until the stalemate is broken and legislators make meaningful progress, we believe investors should take a long-term view. We will be watching the debate closely and will keep you informed of those developments that may affect your investments.
1 For detailed information on the Joint Select Committee on Deficit Reduction, see http://deficitreduction.senate.gov/public/.
2 “The Budget and Economic Outlook: an Update” dated August 2011, Congressional Budget Office, August 2011.
4 The Moment of Truth, The National Commission on Fiscal Responsibility and Reform, December 2010.
5 “Congressional job approval ties historic low of 13%, disapproval rating of 84% highest in Gallup annals“, by Jeffrey M. Jones, Gallup, August 16, 2011.
6 “An olive branch to Obama: I will share the pain” by Steve Schwartzman, CEO of the Blackstone Group, Financial Times, September 12, 2011.
7 The CBOE VIX (Chicago Board Options Exchange Volatility Index) measures annualized implied volatility as conveyed by S&P 500 stock index option prices and is quoted in percentage points per annum. For instance, a VIX value of 15 represents an annualized implied volatility of 15% over the next 30 day period.
8 Bloomberg shows year to date VIX average is 20.85 while July-September 14th VIX measures 20.85.