From the November 2012 issue of Investment Advisor • Subscribe!

After Election, All Eyes Will Be on Lame-Duck Session

If not dealt with, fiscal cliff threats could throw the economy back into recession during first half of 2013

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With the presidential election closing in, political pundits have been weighing in with their predictions on not only which candidate will win, but on which issues Congress must tackle during what political analyst Andy Friedman called “the mother of all lame-duck sessions.”

Friedman, with The Washington Update, told advisors in a recent conference call that they must prepare their clients for higher taxes next year, “at least for more affluent clients—those earning north of $200,000.”

He also noted that under health care reform, those with incomes greater than $250,000 will face a new 3.8% tax on investment income. “Health care reform doesn’t add to the deficit because there are two offsets in the law: next year, investment income will be taxed higher and Medicare outlays will be reduced,” he said.

The other tax on wealthy Americans, Friedman said, will likely come from a compromise between President Obama and Congress regarding the Bush tax cuts, which expire at year-end. Obama wants the cuts to expire for those making more than $250,000, but Republicans want to extend the Bush tax cuts for everyone, including the wealthy.

As Friedman noted in a late September commentary, the lame-duck session will convene primarily between Thanksgiving and Christmas, with the returning Congress being a Republican-led House and Democratic-led Senate, regardless of the election results, he said. “Either [Obama] will have been re-elected—feeling newly-empowered to enact his policies—or he will be a lame-duck president who can do what he believes is right without concern for the consequences,” he added.

But Friedman predicted Obama will “recapture” Independents’ vote and secure a second term in the White House.

Congress adjourned until after the election without addressing the looming “fiscal cliff,” which is caused by legislative changes scheduled to take effect at the end of the year. Chief among these are the expiration of the Bush tax cuts, Friedman said, raising taxes across the board, and the implementation of $2.1 trillion in spending cuts (including $1 trillion of defense cuts) adopted last year as part of the bipartisan agreement to raise the nation’s debt ceiling. “Taken together, the higher taxes and lower spending, if permitted to take effect, are projected to throw the economy back into recession for at least the first half of 2013,” Friedman said.

As to extending the Bush tax cuts, Friedman said, “I think it comes down to what the president wants: let them expire for those families with $250,000 in income. If Congress passes a bill that extends the Bush tax cuts for everyone—[Obama] will veto this because it includes the wealthy,” he told advisors. This means “Republicans have a tough choice: either they say they won’t pass anything and taxes go up or they say ‘fine’ and let income taxes go down for the middle class.” Then, the compromise will likely be taxing those earning $1 million or more, he said.

Given worries over the fiscal cliff—which Friedman said will likely be averted—as well as about taxes, the election and the European debt crisis, “markets will be very volatile” for the remainder of this year.

Another issue that Congress will grapple with next year is tax reform. The House Ways and Means and Senate Finance Committees held a joint hearing in late September on the treatment of capital gains, an issue Rep. Sander Levin, D-Mich., ranking member on the Ways and Means Committee, said will be “the major and most controversial issue” in reforming the tax code. As it stands now the maximum capital gains tax rate is 15%, as compared to the maximum individual ordinary income tax rate of 35%.

Ways and Means Committee Chairman Dave Camp, R-Mich., explained during the hearing that absent Congressional action to stop the impending tax hikes, the maximum capital gains rate will increase to 25% and the maximum individual ordinary income tax rate will increase to “40.8% when certain hidden marginal tax rate increases are factored in.”    

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