Election Impact! Lame Ducks, Bush Tax Cuts and What’s Next

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Well over a year ago, I predicted that President Obama has the better chance of recapturing the Independent vote and winning the 2012 presidential election. I continue to hold that view.

The country is divided almost equally, a third each, among Republican, Democrat, and Independent voters. Rasmussen Report (December 1, 2011). It is not difficult to predict how the bulk of the first two categories will vote. Thus, the election is likely to turn on the Independent vote. My long-standing analysis has been that President Obama has the better chance of capturing the majority of the Independent vote for at least three reasons:

  • Independents are more concerned with economic than social issues. The Republicans have shown a greater tendency to get bogged down in debates over social issues, a discussion that is unlikely to resonate with Independents.
  • The conventional wisdom is that President Obama cannot win re-election with the current unemployment rate. However, Obama is deflecting that blame to Congress by noting that the economy took a U-turn only in 2011, when the Republicans gained control of the House and blocked his programs. Although Republicans will find this assertion unpersuasive, it can resonate with Independents, who give Congress exceedingly low approval ratings.
  • Independents generally do not object to higher taxes on wealthy Americans — no matter how much money they make — might strike Independents as unduly intransigent, particularly in light of the large federal deficit.

The election is far from over. From rising gas prices, to the migration of the European debt problem to our banking system, war in the Middle East, or an unexpected global event could change the election results. Those handicapping the election in the weeks ahead are best advised to follow polls solely of Independent voters.

Lame duck Congressional session:
As was expected, Congress adjourned until after the election without addressing the looming “fiscal cliff” caused by legislative changes scheduled to take effect at the end of the year. Chief among these changes are (i) the expiration of the Bush tax cuts, raising taxes across the board; and (ii) the implementation of $2.1 trillion in spending cuts (including $1 trillion of defense cuts) adopted last year as part of the bipartisan agreement to raise the nation’s debt ceiling. Taken together, the higher taxes and lower spending, if permitted to take effect, are projected to throw the economy back into recession for at least the first half of 2013. An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022, Congressional Budget Office (August 2012).

As of this writing, the fate of the tax increases and spending cuts will be decided, if at all, by a “lame duck” Congress convening primarily between Thanksgiving and Christmas in 2012. The Congress that returns for that session will be the existing Congress — a Republican-led House and Democratic-led Senate — regardless of the election results. President Obama, too, will still be in office during the lame duck session: either he will have been reelected — feeling newly-empowered to enact his policies — or he will be a lame-duck president who can do what he believes is right without concern for the consequences.

Congress may have difficulty deferring the implementation of the agreed-upon spending cuts. Standard & Poor’s and Moody’s have warned that a failure to implement the agreed-upon cuts will result in another downgrade in U.S. debt. Moody’s issues update on the outlook for the US government’s debt rating: Budget negotiations key (September 11, 2012).

This leaves the tax cuts. In my mind, what happens to taxes in the lame duck session will depend crucially on what President Obama wants to do. He believes strongly that, “It’s time to let the tax cuts for the wealthiest Americans expire,” (July 9, 2012). By “wealthy Americans”, the President is referring to families with income over $250,000. The question thus is this: If the lame duck Congress passes a bill that extends the Bush tax cuts for all Americans, will Obama veto that bill because included is an extension of the tax cuts for the wealthy? His advisors say yes: “The president … will veto any legislation that extends the unaffordable Bush tax cuts for the wealthiest in our country.” David Plouffe, senior adviser to President Obama, July 10, 2012.

If President Obama sticks to this view, the Republicans will have a tough choice. Either they will also refuse to take action in the lame duck Congress, in which case the Bush tax cuts expire and taxes next year go up across the board. Most likely the Republicans agree to legislation that keeps taxes low on the middle class and they negotiate the income level above which taxes go up. For his part, the President has signaled a willingness to raise the income level for a tax increase to something above $250,000.

Negotiations in the lame duck session could be complicated by the Republicans’ “Norquist pledge” never to vote to raise taxes. Republicans could conceivably maneuver around that pledge by allowing the Bush tax cuts to expire at year end without Congressional action, and then voting in January, to reduce taxes back to 2012 rates for families under a certain income level. The results would be the same as if the Republicans had agreed to raise taxes above the income level in the lame duck session, but without their technically having voted for a tax increase. Such shenanigans would be unfortunate, as it would perpetuate the uncertainty over taxes beyond year-end.

Some Republicans are now acknowledging the likelihood of a tax increase, at least in the case of Obama’s re-election. Congressman Tom Cole (R-Okla), a member of the House Budget Committee, has conceded that, “This is a referendum on taxes. If the president wins reelection, taxes are going up [for the nation’s wealthiest households]. There’s not a lot we can do about that,” (September 20, 2012).

One final point.
Regardless of what happens with the Bush tax cuts, we already know taxes will increase in 2013. Under the health care reform law, beginning next year compensation income — income from work services — will be subject to an additional tax of 0.9%. Also, taxable investment income — e.g., interest, dividends, capital gains, rents, royalties — will be subject to an additional tax of 3.8%. (The additional tax on investment income will not apply to non-taxable income such as tax-exempt municipal bond interest or to amounts withdrawn from qualified retirement plans and IRAs.) Both of these new taxes will apply only to the extent a family’s overall income is above $250,000 ($200,000 for individual taxpayers). With the Supreme Court’s decision upholding the health care reform law, we now know with certainty these new taxes will go into effect, meaning that — regardless of what happens with the Bush tax cuts — taxes next year will be higher than they are now.

Given the uncertainty surrounding the election and the fiscal cliff, the markets are likely to remain volatile for the remainder of the year. Often markets are volatile before a national election, but calm down once the election is over (regardless of who wins) because uncertainty is reduced. This year, however, volatility may actually increase after the election due to uncertainty about how Congress will address the expiring tax cuts and the fiscal cliff. The rising capital gains tax rates could prompt investors to sell assets to lock in gains near year end, further adding to market volatility.

Andrew H. Friedman is the Principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. He may be reached at www.TheWashingtonUpdate.com.

Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.


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