How will the "fiscal cliff" deal affect you?
On January 2nd, President Barack Obama signed the American Tax Relief Act, an eleventh-hour bill designed to resolve the year-long fiscal cliff debate over expiring tax breaks and automatic spending cuts set to take effect in 2013.
The legislation staves off massive job losses and a potential economic recession, but to Peter Lefkin, Allianz of America's Head of External and Government Affairs, the legislation is somewhat disappointing.
"Washington failed to address the fundamental issue of the day — the $1.2 trillion federal deficit—and failed to secure the goal of $4.2 trillion in combined spending cuts and tax revenue," says Mr. Lefkin. "What they did was resolve problems of their own making. They addressed the expiration of a variety of taxes and temporarily delayed the "sequester" by doing what Congress does best: kicking the can down the road."
While conceding that "I don't think this was a great moment in the annals of political history," Ben Fischer, Founder and Portfolio Manager of NFJ Investment Group, sees some good news in the permanent changes to dividend and capital gains tax rates. "Dividend-paying stocks — especially stocks with increasing dividend payouts — although not guaranteed, may look even better relative to 30–year Treasuries. Americans don't get that many tax breaks, but this is now one of them. So if you stick with the types of stocks that they're practically shouting into megaphones that you should be in, you should do well over time."
Key provisions in the American Tax Relief Act include:
- Marginal Tax Rates: Permanent extension of current policy up to $400,000 for singles, $450,000 for married couples. For taxpayers with more than $400,000 in taxable income or couples with $450,000, the top tax rate would rise to 39.6% in 2013 from 35% in 2012.
- Capital Gains and Dividends: Permanent 15% top capital gains and dividends rate up to $400,000 for singles, $450,000 for married couples; 20% tax rate for both cohorts above those thresholds.
- Estate Tax: Permanent extension of current policy on portability (allowing the spouse to claim the exemption) and unification (gift and tax allowance combined) with a $5 million exemption indexed for inflation and a 40% top rate.
- Alternative Minimum Tax (AMT): Permanently indexed for inflation to mitigate the impact on the middle class.
- Debt Limit: No increase in the debt limit — it remains at $16.39 trillion.
- Sequester: Automatic spending cuts are turned off for two months and paid for with a reduction in the discretionary-spending cap for 2013 and 2014, and expanding eligibility for Roth 401(k) conversion.
Mr. Fischer warns that in the short term, we can expect more market volatility, driven by both "the ineptitude of Congress and the Fed providing enormous liquidity."
"For me, the negatives are less about the deal itself than the political processes behind it," says Mr. Lefkin. "Our leaders are fundamentally unable to come to an agreement on a comprehensive plan to resolve the biggest issue of our time: massive budget deficits that have gone up by $6 trillion over the last five years with no end in sight. They must come up with a game plan to address this issue sometime in the immediate future."
Allianz Global Investors recognizes investors' need for a clear summary of what's happening in the markets now — with an emphasis on usable information to help you make smarter investment decisions.
For the complete breakdown of all the changes in the fiscal cliff law, see the Fiscal Cliff Resource Center on the Allianz Global Investors web site.
And for a discussion by Mr. Lefkin and Mr. Fischer on the implications of this legislation, download their document (PDF), "What the 'fiscal cliff' deal means for investors.'