Taxing Times: What next for investors?

October 25, 2011 Categories: Economic Insights
Net Federal Fiscal Stimulus 2001-2019

Source: Strategas Research Partners, as of October 12, 2011

We are fast approaching November 23rd when the Super Committee presents its plan for cutting the deficit by $1.5 trillion over the next 10 years or face automatic cuts to discretionary and defense spending. Yes, that is the Wednesday before Thanksgiving. In our last Taxing Times we discussed the difficulties legislators face in crafting an agreement for these savings. Their incentive, of course, is to forge a compromise on numerous thorny issues or be voted out of office during the 2012 election cycle.

Whatever their actions, they face these tough scenarios:

  1. The ire of the electorate (this pretty much goes without saying given the 13% approval rating1 in public opinion polls).
  2. Automatic and clumsy cuts to discretionary and defense spending as of January 2012 if negotiations break down before the requisite savings are achieved (see table below).
  3. The knowledge that $1.5 trillion is a small down-payment towards the $4 trillion long-term savings recommended by Standard & Poor’s before considering removing the U.S. from a negative credit watch.

To date, there have been no hints from the Super Committee regarding specific provisions within their November proposal. The absence of leaks and trial balloons has caused lawmakers to grumble about the committee’s secrecy.2 We hear that even the staffers of the Super Committee members are in the dark and lobbyists are nervous. So, in the absence of concrete details, we will consider where potential areas of agreement exist.

Super Committee – Is there Common Ground on some of the issues?

Despite the failures of Obama’s Fiscal Deficit Committee (aka Simpson Bowles Commission) and the Gang of Six (or later Five), some shared sources of saving look likely. Slowing spending rates on entitlement programs and other tweaks are major components of most plans. Curtailing the growth of military spending is another common area to find savings. The table below broadly details the scale of automatic cuts in the event that the Super Committee reaches a stalemate.

Automatic Defense and Discretionary spending cuts estimated by the Congressional Budget Office:

CBO estimates of Automatic Spending Cuts3

Defense Programs  $454 bn
Discretionary Spending  $294 bn
Medicare Savings Caps and Part B $154 bn
Other Discretionary Savings  $47 bn
Debt Service Savings $169 bn
Total estimated savings  $1.118 trillion

Comprehensive Tax reform or another patch to a tattered quilt?

With economic growth still subpar and high unemployment exacerbating the large gap of over 10% between tax receipts and outlays (receipts are averaging 14.2% of GDP while outlays are about 25% of GDP)4, the Super Committee faces a daunting task.

To complicate matters, the economy is facing a stimulus shortfall starting in 2012. Obama’s recently rejected Job’s bill5 attempts to mitigate some of the shortfall by providing stimulus and employment relief costs totaling $447 billion.6 Extending the payroll tax cut through 2012 and 100% bonus depreciation would cost about $200 billion and these may still pass in other legislation. Financing the stimulus with a so-called “millionaire’s tax” (also called the “Buffet tax”), a 5.6% surcharge on incomes exceeding $1,000,000, was rejected by lawmakers.

As we are already in the election season, numerous proposals to fix the economy and tax code are starting to proliferate in the media. Unfortunately, these proposals drown out the basic issues at hand by mixing in large doses of ideology. Put bluntly, lawmakers must grapple with questions of how the government will pay for longstanding programs without sufficient receipts. And how will the government remain a credible borrower in financial markets if meaningful debt repayment is not initiated? Important too, how can tax policy foster economic growth rather than act as a hindrance?

Back to the beginning for investors and taxpayers?

While the Super Committee negotiators appear far apart on many issues, we note that a lot of work has already been done by prior committees. On a positive note, a constituency is growing which supports a pragmatic approach over an ideological one. This would involve comprehensive tax reform for both individual and corporate tax rates and would comprise a broader revenue base, adjusted lower rates if loopholes are closed and simplified filing.Granted, many beneficiaries of loopholes will be upset. However, the threatened alternatives including drastic cuts, political drama and the sense that the U.S. economy is being hindered rather than helped by Washington policies, would not do anyone any good.

While we wait for clarity in Washington, we note that investors and taxpayers will likely benefit when we finally have greater certainty. We will be watching events closely and will keep our readers apprised of important developments.

1 At 13%, Congress’ Approval Ties All-Time Low“, Lydia Saad, Gallup, October 12th, 2011.

2 Many in Both Parties Want a Window into the Deficit Reduction Panel’s Work”, by Robert Pear, New York Times, October 11th, 2011.

3 Figures from Congressional Budget Office Director’s Blog: “Estimated Impact of Automatic Budget Enforcement Procedures Specified in the Budget Control Act” September 12th, by Douglas Elmendorf at

4 Mike Dueker, Russell’s Chief Economist, notes that in 1986, with the largest Reagan deficit, receipts were 17% and outlays were 22% of GDP, a gap of 5%.  When the gap was finally closed in 1998, receipts and outlays were 19.5% of GDP.  Unfortunately, we do not currently have 12 years to close the gap.

5 Revised Jobs Bill Falls in Senate Vote”, by David M. Drucker, Roll Call, October 11th, 2011.

6 Figures from Congressional Budget Office Director’s Blog: “Estimated Impact of Automatic Budget Enforcement Procedures Specified in the Budget Control Act” September 12th, by Douglas Elmendorf at

7 Diving into the rich pool: Imposing higher tax rates on the wealthy can have unintended consequences”, the Economist print edition, September 24th, 2011.

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