DAVID MALPASS: WHAT CAN WE NOW ANTICIPATE
Equities are down hard, more than erasing yesterday’s gains on concern over the fiscal cliff. We think President Obama will try to open a bipartisan discussion on the fiscal cliff, but the scheduled tax increase is a big problem that won’t go away (discussed below). His choice for the new Treasury Secretary will be an important marker for taxes, spending and the debt limit increase.
California’s proposition 30 passed, increasing state income and sales taxes. (Our piece early this morning said it had been voted down.) There’s a major 7-year increase in California state income tax rates — for individual incomes over $500,000 the rate goes to 12.3% from 9.3% (over $1,000,000 filing jointly.) The sales tax rate (currently 7.25%-9.25% depending on locality) will go up by 0.25%. The new taxes are budgeted to maintain $6 billion annually in education spending including community colleges.
We maintain our recession outlook for 2013 based on Europe’s deterioration, weak U.S. business investment, higher U.S. taxes, the U.S. federal and state fiscal and regulatory crisis, and Fed policy which we think is contractionary by channeling regulated credit to less job-rich sectors of the economy. We think U.S. housing is in recovery and China may make stimulative moves on monetary and credit policy, but those won’t be enough to offset the drag.
Regarding the year-end tax increase, a compromise will be harder to reach in 2010 because:
- The House majority is now Republican, was Democrat in 2010; Members are more polarized with more fiscally conservative Republicans;
- The national debt is much bigger, making it harder to reach a kick-the-can fiscal deal as in December 2010 (basically both sides got all the tax cuts they wanted without worrying about the deficit impact or the details of the legislation); extending current rates is more costly than in 2010 because the baseline assumes even more tax increases than in December 2010.
- The President and Republicans have just campaigned hard on distinctly different views of tax rates, making it hard to compromise on the year-end rate hike. The president wants an increase in tax rates for higher income taxpayers while the Republicans believe that would hurt small businesses and jobs and are pledged to opposing tax increases including limitations on tax deductions and credits unless they are matched with lower tax rates.
We think many tax rates are likely to go up at year-end, with most of the increases becoming permanent. Even if there is a partial lameduck deal that temporarily extends some of the current rates, the problem for new business investment is that the tax code is likely to stay in chaos perhaps for years. . The procedural obstacles to reversing January 1 increases are huge as are the obstacles to tax reform.
President Obama will have several techniques to make policy despite the likely Republican House opposition (the House of Representatives is still solidly in Republican control, losing maybe 5 seats from its 241-194 majority).
- The Administration can work to push treaties through the Senate during the lame duck and in 2013 (treaties bypass the House.)
- Undoing the sequester (something both parties want) may give the president an opportunity to increase other high-priority spending.
- Similarly, the emergency supplemental needed for disaster relief for Hurricane Sandy will give opportunities to expand spending and government programs across a broad range.
- The debt limit increase gives the president leverage because of the way the law is written (for example, the August 2011 debt limit increase shifted fiscal responsibility from the President to the Congress through the Super Committee and the sequester hitting defense and Medicare.) We’ve advocated rewriting the debt limit so it restrains spending when over the debt limit.
- Many regulations for Obamacare and Dodd-Frank are still being promulgated. Because the laws were written loosely, there is an unusually large policy impact from the wording of the regulations.
- The new Consumer Finance Protection Bureau inside the Fed has immense power because it operates outside the appropriations process and has unlimited funding. One of its most ambitious proponents, Elizabeth Warren, won a Senate seat in Massachusetts.
- There’s likely to be a further expansion of the global governance processes through the United Nations, G20 and IMF (which is off budget.)
- The President has proposed a new Department of Business and the establishment of nationwide manufacturing institutes. These would take compromise with the House.
- The President may have the opportunity to make one or more Supreme Court appointments. He will also make numerous appointments to lower courts with the advice and consent of the Senate.
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