A few thoughts on Fiscal Agreement

A personal note: I'd like to thank Governor Romney for his personal sacrifice. I believe he is a decent man, and I think everyone should appreciate the sacrifice all candidates made in running for office (I'd never do it, even at the local level). I also think President Obama is a decent man, and I remain optimistic about the future.

From Reuters: Obama to Make Statement on Economy Friday

The president is likely to discuss looming tax increases and government spending cuts — the so-called fiscal cliff — that would go into effect early next year unless Congress acts to prevent them. He is due to make the statement from the East Room of the White House at 1:05 p.m.

As I've noted before, there is no "cliff" and January 1st is not a drop dead date. Note: In the comments, Jackdawracy suggests "Fiscal Hillock" and energyecon suggests "fiscal bluff".

There are a few things that appear certain (but you never know with policy):

1) The top marginal tax rate will increase from 35% to 39.6%. The details still need to be worked out (at what income the highest bracket will start, and what happens with dividends and capital gains). The it is pretty clear the top tax rate will increase.

2) The payroll tax cut is probably going away. This was the 2% payroll tax reduction that workers received in 2010 and 2011. For a family with a $50,000 per year income, this is a tax increase of about $20 per week.

3) The Alternative Minimum Tax (AMT) relief will probably be extended (it is every year).

4) Given that the top marginal tax rate will increase - and that certain politicians can't vote for any bill with a tax increase - the agreement will probably be voted on in January after the Bush tax cuts expire.

I doubt we will see the current scheduled defense spending cuts (aka "sequestration"), but there will probably be some defense cuts.

Probably the most controversial issue, and least economically important (minimal drag on economy) is raising the top marginally tax rate. High income earners have a propensity to save, and raising their marginal rate a few percentage points will not have much impact on the economy - but it will significantly reduce the deficit.

Click on graph for larger image in new window.

This graph shows the top marginal tax rate since 1920. There are many details missing (like the level of the top tax bracket). The current proposal is to raise the top tax bracket back to 39.6% from 35% - the same level as in the '90s.

Back in 1993, many analysts (like Larry Kudlow) argued raising the tax rate from 31% to 39.6% would take the economy into a deep recession or even depression. They were wrong. The other parts of the "fiscal cliff" are more important for the economy in the short run than the top tax rate.

One of the arguments against raising the top tax rate is that it will be a disincentive to start new companies. Wrong again. Note the top marginal tax rate in the 1970s - it was 70%. That was when Bill Gates started Microsoft, Steve Jobs started Apple and ... many others (Thomas Peterffy, who founded Interactive Brokers and ran many political ads recently started his company in 1977 with a 70% top tax rate). I've met with many entrepreneurs over the years, and none of them even mentioned the top personal tax rate - they were too focused on their company, products and market.

Hopefully this fiscal issue will be resolved without much disruption, and my guess is some sort of compromise will be reached early in 2013.