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.