In the summer of 2015, either one or both political parties will
begin the search for their next presidential candidate (depending
on whether Mitt Romney wins the election this fall). By that time,
the whole tenor of political positions will have sharply
changed.
At least, we can only hope so.
That's because our
economy
is unlikely to handle three more years of gridlock, which keeps us
stuck in a phase of higher government spending and shrinking
revenue. Any day now, the ever-rising mountain of debt will need to
be addressed. In the face of inaction, the
bond
market
will have spoken by 2015 anyway, as "bond vigilantes" force the
government to get a grip on the never-ending deficits.
Let's hope it doesn't come to that, but just in case, you need
to be prepared.
Right now, we have a pretty clear read on the broadly-staked
positions of the Democratic Party. Yet signs are emerging that
we'll see a bruising battle for the heart and soul of the
Republican Party. How it plays out will help shape what the U.S.
government looks like in 3-4 years.
In recent weeks, we've seen GOP primary victories by tea party
candidates for the Senate in Indiana and Texas. In Texas, tea party
darling Ted Cruz defeated Lt. Gov. David Dewhurst by a 4-to-3
margin
-- and Dewhurst already had pretty deep conservative bonafides. In
Indiana, long-time Sen. Richard Lugar is one of a long line of
center-right conservatives that has been shown the door.
Make no mistake, the ascent of the tea party, first in the House
of Representatives, and now perhaps in the Senate, will likely set
up a pitched intra-party battle in early 2013. Already, signs are
emerging that more moderate members of the GOP have hinted at a
willingness to compromise with their Democratic counterparts in
addressing
the coming "fiscal cliff"
and longer-term budget repairs. Until now, almost every member of
the GOP has voted in line with the party platform. If the tea party
strengthens its grip, then don't be surprised to see more moderate
GOP members "cross the aisle" on crucial votes.
What it means
If you buy into the logic that our budget deficits will have to be
addressed and if you believe that bipartisan compromises will be
the only way to achieve that, then we already know how some of this
will likely play out.
For example,
defense spending is bound to shrink
, though not nearly at the draconian rate that the current fiscal
cliff scenario envisions. President Obama and GOP nominee Mitt
Romney appear committed to increasing defense resources for the
Asia/Pacific region, especially in terms of naval strength. By
definition, this means a reduction in ground forces elsewhere, and
a cutback in other forms of hardware. The Amex DefenseIndex seems
to ignoring this looming change in defense spending.
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Fed to states: Not our problem
Early in his term, President Obama sought to help out the 50
states, many of which were facing drastic revenue shortfalls. The
salaries of teachers, police officers firefighters were temporarily
supported by federal grants -- yet the notion of further support
for states has become anathema.
Even as states have started to plug budget gaps through
widespread layoffs and slowly rebounding tax receipts, there's more
pain on the horizon. Unless we see significant reworkings of public
sector labor agreements, especially in the area of health care and
pensions, then state-level finances will only worsen with time. In
the absence of federal support, the culling of local and state
labor forces is bound to continue.
In terms of health care, the recent decision by the Supreme
Court to uphold the key tenets of the Affordable Care Act is just a
step in the process. Containing total health care spending while
expanding coverage is a lofty goal, but many changes are likely to
be made along the way until we get it right. This likely means even
fewer dollars per patient when it comes to drugs, devices, home
care services, hospital stays and other health care items. If you
own the stocks of health care companies, then you need to figure
out if they will be more useful or less useful in world where every
cost comes under pressure. [For my take on this,
read this article
.]
As this chart shows, Japan spends roughly half as much on
healthcare as we do, yet arguably has superior outcomes (in areas
like longevity and infant mortality). Though this chart is from
2009, little has changed since.
Sacrosanct deductions: Not anymore
Perhaps the biggest changes to come involve the tax code. Right
now, many are focused on the possible extension or elimination of
Bush-era tax cuts. It looks increasingly likely that taxes -- at
least for the wealthiest Americans -- will be going up, even if
Romney wins the election. Conservative economists such as Bruce
Bartlett and David Stockman who have worked for past Republican
Presidents now concede that prolonging our fiscal crisis by
extending tax cuts on top earners starts to become detrimental for
the economy, which greatly affects the "investment class."
Yet even a return to the tax rates of the Clinton administration
won't simply close out budget gaps -- even if government spending
shrinks. That's why a wide range of
tax deductions
will eventually be on the chopping block. By eliminating
deductions, politicians can essentially claim that they didn't
raise tax rates.
For example, it's hard to see how deductions for
mortgage
interest and charitable giving can survive any budget fix. These
deductions may get preserved to an extent, but are likely to be
trimmed to some degree.
And we're not just talking about individual income taxes. Both
parties have taken note of the fact that U.S. companies face some
the highest tax rates in the developed world, and a drop in those
rates could boost corporate effectiveness. To achieve that, both
parties have expressed a willingness to trim tax deductions so that
major corporations such as
GE (NYSE:
GE
)
no longer get away with an
effective tax rate
of 10% -- or less. In effect, the stated
tax rate
for all corporations may go down, but total tax receipts from
corporations are likely to go up.
The big new tax that has increasing bipartisan
support
With a tax code larded up with deductions, the reality is that many
Americans end up paying a lower tax rate than they realize. And
although many members of the GOP are loathe to raise taxes, they
would like to see a simplified tax code. However, the goal of
reducing the overall tax rate to just a few basic categories may
still end up expanding our budget mess.
Yet some of these same legislators have suggested a reasonable
fix: tax consumption.
By adopting a national
sales tax
(known as a Value Added Tax or VAT in other countries), the
government could raise revenue without hiking income taxes. Using
FairTax.org's
platform as an example, "every person living in the United States
pays a 23% national sales tax on purchases of new goods and
services. This rate is equal to the lowest current income
tax bracket
(15%) combined with employee payroll taxes (7.65%), both of which
will be eliminated."
That's a pretty stiff VAT rate -- even higher than what is seen
across Europe, and would surely raise the hackles of any
consumer-facing business. If we are to get a VAT, then it is likely
to be closer to 5%, and other income taxes would stay in place (and
not be eliminated as these folks suggest).
Yet the appeal of a VAT is undeniable. Taxpayers would benefit
from a less complex tax code, and the ability to cheat on taxes
would be reduced.
Grow our way out of it?
Both parties may have been dragging their feet in tackling these
tough choices in hopes that economic growth would help save the
day. After all, a rising economy in the 1990s helped bolster
government tax receipts to the point where a chronic
deficit
briefly become a surplus. That's unlikely to happen these days for
the very simple reason that the budget mess is partially
responsible for the uncertain economic environment that is leading
to tepid job creation.
Washington can't sit and wait for things to get better. The
large budget deficits have been a concern for almost a decade now,
and every year, the can has been kicked down the road. Yet it's
impossible to see how this can last much longer. That's why we'll
be talking about a different set of issues by 2015, when the next
election season rolls around. By then, we'll have already been
forced to make major changes -- which by definitionmean higher
taxes and a smaller government. That's a Solomonic solution that
few will relish, but is nearly unavoidable.
Action to Take -->
The concern isn't simply that taxes will go up for those that
already feel over-taxed. Or that the government's support of a wide
range of programs will sharply erode. Instead, it's the actual
effect of a change in the tax-and-spending dynamic on the economy
and stock market.
Though persistent budget deficits have many harmful effects on
our future economic competitiveness, they provide a clear boost to
the economy and the market in the short term. Think about it... A
government that spends more than it takes in is adding liquidity to
the economy. In recent years, we're talking about hundreds of
billions of dollars of liquidity.
Yet a move to raise taxes and shrink spending does the opposite.
It sucks money out of the economy. Of course, eliminating budget
deficits simply moves the government into a neutral posture. But
our total government debt is so high that this neutral posture may
not last. Instead, the government will eventually be forced to
reduce our massive debt, which means running a government
surplus--which pulls money out of the economy. That was manageable
in the late 1990s when the economy was on a robust plane of growth.
But today's politicians -- nor the ones who will be pondering a run
for the White House in 2015 -- will likely be operating in an
environment of robust growth.
[
Note:
Andy Obermueller, editor of StreetAuthority's
Game-Changing Stocks
newsletter, has made a series of shocking predictions that could
affect your portfolio for the rest of 2012 -- and beyond. To see
all of his predicions -- and learn which stocks could protect you
from the coming storm --
read this special report.
]
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.