Market Insights January 2013 Fiscal Cliff Part II The Debt Ceiling Looms The first fiscal cliff to be avoided was sealed at the last minute at the end of 2012. Tax rates for 99% of households will remain the same, and rates for the top 1% will rise sharply. This is a political victory for President Obama since this is the first time in more than two decades that Republicans voted for higher taxes in both the Senate and the House. At the same time Mr. Obama made no meaningful concessions on spending. Although this was a political victory, it was less a win for the economy. Almost nothing was done to arrest our escalating national debt in the long run. Even the President said that we still have deficits that have to be dealt with. This did delay the sequester : the across-the-board automatic spending cuts, for only two months. This is where Part II comes into play. The debt ceiling was not raised, and without such an increase, the Treasury will have to suspend new bond issues and stop paying some bills. The following table summarizes the main issues that were not addressed, incurred, delayed and avoided in the first round of addressing the fiscal cliff. HSW Advisors 505 5th Ave., 14th Floor New York, NY 10017 212-286-1170 1
Fiscal Cliff-edge: To Do List Fiscal contractions scheduled for 2013 and their fate Component Annual Impact $ bil Status No Action Debt ceiling -- No action taken. To be addressed within the next 2 months Incurred Tax rates on wealthy 42 * Raised permanently Payroll tax cut 115 Expired Higher Medicare tax 24 Enacted as scheduled 2011 discretionary spending cuts 60 Enacted as scheduled Delayed Medicare fee cuts for doctors 11 Delayed 1 year Expiration of extended unemployment 30 Delayed 1 year benefits Routine business and individual tax 69 Extended 1 year breaks Sequester: across-the-board automatic spending cuts 110 Delayed 2 months Avoided Maintain middle class tax rates; fix 197 * Permanent ^ estate, capital gains and dividend tax rates Patch the alternative minimum tax 105 * Patched permanently *Fiscal year 2014 ^Some tax credits extended for 5 years Sources: Congressional Budget Office (CBO); Joint Committee on Taxation; Office of Management and Budget (OMB); Tax Policy Centre Although our rising deficits were not tackled to any great extent, all is not lost. The 2012 yearend political deal does have some redeeming features. It avoids about $200 billion in tax increases a year, restores stability to the tax code, although perhaps not for long, since it still generates too little revenue. Some of the main points include: The lower tax rates enacted by President Bush in 2001 and 2003 which expired on December 31, 2012 were reinstated and made permanent for everyone except individuals earning over $400,000 and couples earning more than $450,000 per year. Their tax rate rises from 35% to 39.6%; the same levels pre-2001. Individuals earning over $250,000 will lose some tax deductions. HSW Advisors 505 5th Ave., 14th Floor New York, NY 10017 212-286-1170 2
Capital gains taxes and dividend tax rates will rise from 15% to 20%, but these are lower than the pre-2001 levels. Estate taxes are raised but are still below 2001 levels. The $5 million gifting exclusion, tied to inflation, stays in place. Expansions to tax credits for families, workers and college students enacted by President Obama in 2009 will remain in place for 5 more years. The AMT, a supplemental tax for the wealthy, has been permanently fixed to avoid ensnaring even more middle class families each year. Payroll Tax. The deal allowed a 2-percentage point payroll tax cut to expire which will reduce purchasing power for workers by about $1,000 per family. The expiration of the payroll tax, combined with higher taxes on the wealthy and some federal spending cuts, will lower GDP this year by 1.0% 1.5%, most of it should be felt in the first half of the year. The overall agreement, however, barely dents the additional $10 trillion in deficits that we are on track to accumulate over the next decade. In addition, Obamacare begins at the start of 2013. Under the Patient Protection and Affordable Care Act (PPACA - 2010) in combination with the Health Care and Education Reconciliation Act of 2010 (HCERA), for certain high-income earners, there will be an: Expansion of the FICA payroll tax (from 1.45% to 2.35%), and A new investment tax - 3.8% on net investment income which generally includes unearned income. FICA, the Federal Insurance Contributions Act, is a US payroll tax imposed on both employees and employers to fund Social Security and Medicare. The Social Security portion currently stands at 4.2% of gross compensation of a wage base of up to $110,100. The additional 0.9% FICA Hospital Insurance Payroll Tax increase affects married couples filing jointly who earn over $250,000 per year, married individuals filing separately earning $125,000 per year, or single individuals or heads of households earning $200,000 per year. Unlike the Social Security portion of the FICA tax, the Medicare portion of the tax does not cease to apply at any particular wage level. The 3.8% Medicare Contribution Tax will be imposed on certain unearned income of individuals, trusts, and estates. This tax is in addition to any other income taxes the taxpayer may owe. For individuals, the tax is calculated by multiplying the 3.8% rate of by the lesser of: Net investment income for the year, or Modified adjusted gross income (MAGI) exceeding the threshold amount HSW Advisors 505 5th Ave., 14th Floor New York, NY 10017 212-286-1170 3
Net investment income includes income such as: interest, dividends, capital gains, annuities, rents, royalties, passive income from a trade or a business. Net investment income will not include items such as: distributions from qualified plans, IRAs, pension or profit sharing plans, tax exempt income, income subject to selfemployment tax, cash surrender value building up inside a life insurance policy or royalties from oil and gas production. Note that there are complex calculations and nuances involved with these taxes, and we encourage you to consult with your tax advisor on how these changes may affect your taxes. Neither HSW Advisors nor HighTower Advisors offers tax advice. **************** All of these additional taxes should slow the growth of the US economy, however, in spite of these projections for slower growth the equity markets rose sharply as the fiscal cliff deal emerged at the end of December 2012. Now comes part II of the fiscal crisis: the debt ceiling issue, which looms ahead of us in less than 2 months. Although President Obama states that he is very open to compromise with the Republicans, he also states that he will not negotiate over the debt ceiling as he did in 2011. Further deficit reductions, from Mr. Obama s point of view, will require tax rates to go up again. As he stated on December 31: if Republicans think that I will finish the job of deficit reductions through spending cuts alone, they ve got another thing coming. This upcoming battle between Republicans and Democrats on the debt ceiling may become even more protracted now that President Obama has nominated Jack Lew to become the new Treasury Secretary. Whereas Tim Geithner was a banker tapped to handle the 2008-09 banking crisis, Jack Lew is a budget professional being nominated to deal with the Government s current fiscal woes. Mr. Lew helped President Clinton strike the 1997 balanced budget accord as a top official at the Office of Management and Budget. Lew went on to run this agency for both Mr. Clinton and Mr. Obama, and he played an important role in the contentious 2011 debt ceiling debate. Jack Lew s combination of policy expertise, tough stances and liberal views rub some top Republicans the wrong way. This echoes the more strident negotiating stance that the White House pursued in the fiscal cliff battle at the end of 2012. As the financial markets reacted to the day to day news in late 2012, we should anticipate more of the same as Democrats and Republicans gird for the next battle the debt ceiling. HSW Advisors 505 5th Ave., 14th Floor New York, NY 10017 212-286-1170 4
HSW Advisors is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC. The information provided has been obtained from sources not associated with HighTower or its associates. All data and other information referenced herein are from sources believed to be reliable, although its accuracy or completeness cannot be guaranteed. Any opinions, news, research, analyses, prices, or other information contained in this report is provided as general market commentary, it does not constitute investment advice. HSW Advisors and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. This document was created for informational purposes only; the opinions expressed are solely those of HSW Advisors, and do not represent those of HighTower Advisors, LLC, or any of its affiliates. 1409483--2013.01 HSW Advisors 505 5th Ave., 14th Floor New York, NY 10017 212-286-1170 5