January 3, 2013
There was a sigh of relief heard round the world Wednesday as Congress used New Year's Day to close the curtain on "fiscal cliff" theatrics and save most Americans from sharp tax increases that were expected to induce a recession.
But as the Dow Jones industrial average climbed 308 points Wednesday, along with robust rallies in Europe and Asia, Wall Street analysts were warning that Americans have simply been treated to an intermission in the Washington drama. The posturing will begin again over the nation's debt ceiling and government spending cuts that will become automatic in two months if politicians continue to duck and weave.
The "limited scope" of Tuesday's tax deal "and the need for additional negotiations will likely translate into increased volatility for financial markets," said Russ Koesterich, global chief investment officer at BlackRock. "Expect more late-night drama from Washington in the coming months."
Late February could be as unnerving for investors as was late December, when stocks dropped 3 percent in the days leading up to year's end. Then, again, 3 percent wasn't much of a drop considering the ugly prognostications of a recession if an agreement hadn't been forged. Perhaps investors have learned the script from the latest political drama and will simply ignore political rhetoric when deadlines force lawmakers' hand again.
If Congress disappoints then, what could be at stake is an embarrassment for the U.S. as the government reaches its debt limit and can't operate fully or pay bills on time. A resulting downgrade of the nation's credit rating could make investors more cautious about buying U.S. bonds and could increase the interest the nation must pay to attract investors — adding to the country's debt.
Still, Standard & Poor's said Tuesday that the latest move by Congress to kick most of its debt issues down the road would not prompt a debt rating change now.
And most analysts say Congress' decision to relieve most Americans of major tax increases will let the nation avoid the recession that had been predicted.
The nation's growth is expected to slip somewhat, however, because Americans will have to pay higher payroll taxes than they did in 2012. Americans were given a temporary reprieve from payroll taxes that go to Social Security as a stimulus measure amid the recession. But later this month, as people open paychecks and see those taxes at 6.2 percent instead of 4.2 percent, those who live paycheck to paycheck are expected to cut their spending.
The higher payroll tax will take $1,000 a year out of pay for people earning $50,000, said Mark Luscombe, tax analyst for CCH. So a biweekly paycheck could be slimmed by about $40.
The $120 billion increase in payroll taxes is expected to reduce personal income about 1 percent.
Meanwhile, analysts expect individuals earning $400,000 and couples earning $450,000 to cut back a little on discretionary spending because their tax rate will climb to 39.6 percent from 35 percent. In addition, they will face limits on future tax deductions and higher taxes on capital gains and dividends — 23.8 percent versus the current 15 percent.
"The deal will shave about 0.75 percent from the nation's growth rate," estimates Mark Hopkins, economist with Moody's Analytics. But that's better than the sharp hit estimated had the nation gone over the fiscal cliff, with all taxpayers facing higher income taxes totaling about $500 billion.
The economy could lose another 0.25 percent from growth this year if the next round of debate over the nation's debt in February ends with government spending cuts happening as now proposed, Hopkins said. Those cuts are largely focused on defense, but other industries would be nicked too.
Without the tax increases just adopted and the spending cuts that might be implemented, Hopkins estimates the economy in 2013 would grow at 3 percent. With the tax increases and spending cuts, he thinks a lackluster growth rate of 2 percent is more likely.
Meanwhile, Macroeconomic Advisers is estimating a growth rate of 2.7 percent for 2013 and 3.2 percent in 2014, with unemployment ending 2014 at a still-high 7.1 percent.
Economists say the economy needs to grow at about 4 percent to start stimulating serious job growth. That's a major reason why economists pushed federal lawmakers to delay immediate tax increases and to lay out a long-term plan to control the nation's debt.
"The good news is that the worst-case scenario of an immediate slide back into recession had been avoided, and we do have a little more certainty about taxation," said Paul Ashworth, economist for Capital Economics.
But Ashworth added that renewed fears about the U.S. fiscal position "may still return to rattle the markets and keep spending subdued."
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