In the summer of 2015, both political partieswill begin the
search for their next presidential candidate. By that time, the
whole tenor of political positions will have sharply changed.
At least, we can only hope so.
That's because oureconomy is unlikely to handle three more years
of gridlock, which keeps us stuck in a phase of higher government
spending and shrinkingrevenue . Any day now, the ever-rising
mountain of debt will need to be addressed. In the face of
inaction, thebond market will have spoken by 2015 anyway, as "bond
vigilantes" force the government to get a grip on the never-ending
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.
Make no mistake, the ascent of the tea party in 2010 followed by
the Republican Party's defeat in the Presidential Election (along
with key Senate races) in 2012 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 platformWhat 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...
1. Defense Spending
|Index seems to ignoring this looming change in defense
States begin to suffer (again)
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
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.
Obamacare 's effect in full view
In terms of health care, the recent decision by the
Supreme Court to uphold the key tenets of theAffordable
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 thestocks 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
4. Deductions down,taxes up
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. 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
oftax 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 formortgage
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 takennote 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
no longer get away with aneffective tax rate of 10% -- or
less. In effect, the statedtax rate for all corporations
may go down, but total tax receipts from corporations are
likely to go up.
Nationalsales tax ?
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. Usingtax 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
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 chronicdeficit 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
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 ofissues 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 addingliquidity 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 sucksmoney 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.
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