Friedman Sees Fiscal Cliff Colliding With Obama’s Legacy

Longer term, political analyst says president’s legacy will ride on his ability to bring down the deficit

Andy Friedman is a political analyst with the Washington Update. Andy Friedman is a political analyst with the Washington Update.

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A hard-fought election campaign in which billions of dollars were spent brought us to exactly where we started – with President Obama in the White House and a divided Congress, and now a lame-duck session that carries the weighty responsibility of shepherding the nation past the fiscal cliff.

So says Andy Friedman, political analyst with The Washington Update and a regular on the advisor lecture circuit, in a post-election commentary about the strangely familiar political landscape and the effect investors can expect in financial markets.

Friedman said, “Presidents spend their first terms worried about getting re-elected. They spend their second terms worrying about their legacy.”

That legacy depends heavily on the massive federal budget deficit, a problem that he says cannot be solved without reforming Social Security, Medicare and the tax code. It remains to be seen whether the president will follow through on a statement he made last month that he would address the deficit early in his second term.

There will be no respite for legislators in the balance of this year, as the expiration of Bush-era tax cuts and severe spending cuts mandated by Congress last year are scheduled to take effect in 2013, a combined fiscal jolt that is widely projected to throw the economy back into recession.

Friedman notes the straitjacket-like circumstances of the next couple of months. Politicians on both sides of the aisle want to avert this fiscal cliff, but Standard & Poor’s and Moody’s have warned they will downgrade U.S. debt if the nation does not adopt budgetary discipline.

That’s where the political jockeying comes in. “If Congress passes a bill that extends the Bush tax cuts for all Americans, will Obama veto that bill because included is an extension of the tax cuts for the wealthy?” His advisors have signaled he would, Friedman says. If that is the case, then Republicans will have difficulty. If they take no action in the lame-duck session, the Bush-era tax cuts they support will expire; a compromise that would allow taxes to rise for the wealthiest Americans would run afoul of their core principle that only a simplified tax system promotes efficiency and growth.

Friedman expects the Republicans to request an extension of the Bush tax cuts till Congress can enact broad reform next year and he foresees the president rejecting that request, preferring to enact any changes in the law after tax increases take effect next year.

“Regardless of what happens with the Bush tax cuts, we already know taxes will increase in 2013,” Friedman writes, looking beyond the lame duck session. That is because two new taxes enacted as part of Obamacare and legally vetted in the Supreme Court’s decision upholding the controversial legislation will take effect in January: a compensation income tax of 0.9%and an additional tax of 3.8%on interest, dividends, capital gains, rents and royalties for families with income over $250,000.

The increased taxes on investment income, capital gains in particular, could prompt further stock market sell-offs as investors seek to lock in their gains before the new tax regime takes effect.

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