Fiscal cliff will usher in profound change

Inman News

Most people seem to feel some sense of relief at the passing of the election, but markets are apprehensive. We need for big stuff to happen, and we know that more will happen now, faster than it has in years. But we don't know what will happen, or to what effect.

The daily flow of economic data causes upsets, but reassures markets -- at least we know where we are. For the next month Hurricane Sandy will distort to uselessness most of the usual reports, as it did this week's shaky ones for retail sales, unemployment and industrial production. Maybe a new trend, maybe nothing.

Sandy had nothing to do with the rest of the world. Eurozone industrial production in September fell sharply, down 2.5 percent in the month. Third-quarter eurozone GDP fell by 0.2 percent annualized, negative for the second straight quarter and three of the last four. Japan's third-quarter GDP sank 3.5 percent. China's official reports cannot be trusted, not during a leadership change. Nobody outside the new Politburo Standing Committee knows what the change means -- and maybe not even those seven men.

Against that backdrop the U.S. has embarked on the most profound change in its finances since the income tax began in 1862. The stock market had a bad day after Obama's victory, but the cause appeared to be Europe. Since then, the straight-down stocks seemed to be anticipating his newly announced tax-negotiating position.

"The wealthy don't need a tax cut." Fair enough. However, the reversal of a tax cut made 11 years ago amounts to a tax increase, in every way and effect.

But because the president's proposal affects only the top 2 percent of income earners, it's a painless way to raise money. So those in favor say.

Over 10 years, increasing the rate on the top two tax brackets (from 33 percent to 36 percent, and from 35 percent to 39.6 percent) would raise $441 billion. Limiting deductions by these taxpayers, another $123 billion. Another $206 billion from new taxes on dividends plus an inevitable increase in capital gains taxes ... the link to sinking stocks is unmistakable.

The very worst of the lies today about taxation: "We have had higher brackets for the rich and not hurt the economy." We have had higher brackets, but nobody paid them in previous systems that were more loophole than collection. Pulling $800 billion-plus out of the pockets of 2 percent of taxpayers will have negative economic effect.

Some spending cuts will come soon, but very few. There will be no cuts in current social spending (Obamacare will add). The reductions will come in the form of promises, not taking effect until late in the decade. The front-loading of taxes and back-loading of spending cuts makes Republican negotiators nervous. And should, based on the history.

The great tax reform of 1986 removed many prior loopholes and reduced brackets to two: 15 percent and 28 percent. But by 1990 that reform was not generating enough revenue to fund social spending above forecast.

We raised brackets and closed loopholes. In 1993, President Clinton reached a grand deal: Raise the rate on the top bracket to 39.6 percent in exchange for hard limits on spending. That, along with a tech-fueled economic boom and a stock market bubble, created a budget surplus. Clinton's deal was fair and effective, but that economy was not authentic, and we will be reapplying those brackets now to a far weaker economy.

The most extraordinary change in the works: For the first time since 1862, a no-loophole system. Thus at any given bracket, the effective rate of tax will be higher than ever.

Some think a "cliff" deal will reassure business and help the economy. More likely, everyone affected will know that austerity has arrived on our shore, and our hopes will rest on a far more adaptable economy than anywhere else. Good bet, too.

The prospects for a deal have improved now that two hardheads who, from a distance undermined House Speaker John Boehner's efforts in 2011 -- Paul Ryan and Eric Cantor -- will now join the negotiating team. On the other side, all will depend on the extent of President Obama's determination for righteous extraction of cash from people who neither need it nor earned it.

Temporary bad news today on another front: the bankruptcy of the maker of Twinkies and Wonder Bread. (In my childhood, my mother said they called it that because we wonder if it's bread.) Take heart: The brands will be sold and revived. Couldn't make it through a time like this without an occasional smuggled Twinkie.

The National Federation of Independent Business Small Business Optimism Index is one of the very best economic measures, in part because the survey goes back almost 40 years. Small-business conditions have been unchanged since the end of 2010, stuck below any recession bottom since '81.


Survey of 2,029 small-business owners conducted in October 2012. Source:NFIB.com.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@pmglending.com.

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