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Kent Thune

Fiscal Cliff 2013: Looking Beyond the Election

By October 20, 2012

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While the nation focuses on the 2012 presidential election, the prudent investor will begin looking at the so-called "fiscal cliff" looming around the corner.  What will happen January 1, 2013 if politicians don't address this issue before year's end?

What is the 'Fiscal Cliff?'

The Bush-era tax cuts, which were extended for two years in 2010, are set to expire at the end of 2012.  The result will have the same effect as a tax increase and can have significant and negative impact on the economy.  Here are the basics of what will happen if we fall over the proverbial fiscal cliff:

  • Every income group would see their tax rate rise by an average of 3.5% but the top 1 percent of US households would face the largest tax increases in 2013.
  • Various estimates of tax increases for the top 1% range from $200,000 per year to $600,000.  Most economists and financial news sources estimate the middle class would see an increase of about $2,000 per year in taxes.
  • Low-income households would experience reductions in the Earned Income Tax Credit and the Child Tax Credit.
  • Upper middle-income households would be hit again by the Alternative Minimum Tax and pay higher rates.
  • Capital gains rates would increase from 15% to 23.8% and dividends tax rates would increase, which would erode at investment returns and put less money in savers' pockets.

Will We Be Forced Over the Fiscal Cliff?

Congress can continue to do what they've been doing for years--nothing--and harm the economy or they can compromise.  It is also possible that politicians will play chicken with the economy and decide to finally do something some time in 2013 before the impact can be felt (taxes from 2013 won't be due until April of 2014).

Perhaps the greatest impact on mutual funds and capital markets in general is that the fear of the fiscal cliff can create uncertainty and influence investors to sell stocks and thus push the market down: The fear of the cliff can be worse for investors than falling off of it.

As always, the best remedy for such uncertainty and potential market volatility is to build a solid portfolio of mutual funds.

Comments
October 22, 2012 at 8:58 am
(1) Mike says:

taxes from 2013 won’t be due until April of 2014

This is not completely true, correct? The tax increase (especially the AMT change) is high enough that many people will be required to make a quarterly estimated tax payment in April of 2013, in case no compromise is reached, including many folks that have never heard of “estimated tax”.

October 22, 2012 at 12:07 pm
(2) Kent Thune says:

Great point, Mike. There are rarely absolute truths in taxes (and in life)! I presume you are referring to the post’s statement, “taxes from 2013 won’t be due until April of 2014.” In fact, I may be included among those paying higher estimated taxes beginning in April.

Again, this information is general in nature and it does not apply to everyone the same way.

Thanks for the comment and for adding value to the post here…

Kent Thune
Mutual Funds Guide

October 28, 2012 at 7:23 pm
(3) Government Employee says:

These facts and advice border on insanity. The cliff is so huge, it would require rasing taxes on all non-government workers by around $9,250 for six years.

The result will be the Federal Reserve printing much more money. Bonds today, will be repaid. But, the huge inflation will make a $1,000 bond good for buying one cup of Starbuck’s coffee.
Yes, bonds will be repaid, but the massive debt and printing to cover it will make the value of the US Paper Dollar basically worthless.

Bonds (debt) are the worst investment possible at this point.

October 28, 2012 at 9:24 pm
(4) mutualfunds says:

“Government Employee:”

I appreciate your comment. I don’t doubt your estimations, primarily because there is so much information (or should I say opinions) in the financial media about the potential impact of the so-called “fiscal cliff” that it is difficult to make a concrete case about its true size and depth.

For this reason, I used figures that are common on many different financial news sources I have read over the past few weeks.

Not that my posting here requires any defense, I made no “advice” other than to suggest readers build a diverse portfolio of investments, which is arguably prudent in any environment, predictable or not.

I do agree that individual bond securities are generally not a good investment now. However, if your predictions hold true and “massive debts and printing to cover it” continues, bond mutual funds can be better than bonds, at least through the middle of 2013 (yields falling as prices rise).

If you are still engaged in this conversation, I’m sure my readers would like to learn more of your reasoning and information, in specific terms, about how your predictions may unfold.

Thanks again for the comment…

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