Perhaps it is appropriate that 2012 will end amid suspense over Congress' ability to agree before midnight on legislation averting the worst of the fiscal cliff. I still see odds of success at just above a toss-up, and I assume that anticipation of such a result might give an early boost to equity prices. Nevertheless, "nothing done" remains a possibility -- or a TARP moment in the House that could reverse sentiment and lead to volatility throughout the day.
Even the scope of a deal remains in question, with the destructive impact of across-the-board defense and non-defense spending cuts that could emerge in any event finally winning focus. Prospects for inclusion of a fix for the sequester seem a push at best, with major upside -- or downside -- seemingly in store for defense stocks as a result. Perhaps more certain in the event of a deal would be relief for health care providers at risk to a 27% reduction in physician fees, although this would be tempered by Medicare-related cuts should a sequester be triggered.
I continue to urge investor caution, even should a deal emerge, as the impending straddle into 2013 will only yield to a seamlessly renewed fight over spending and the debt ceiling that could continue to weigh on investors and the economy well into February or beyond.
Both houses of Congress are in session Monday to act on a hoped-for agreement, with an expediting procedural move adopted by House Republicans preserving the prospect for that chamber to vote later today on any legislation that might pass in the Senate. Meanwhile, in a wild card, House members fearing being forced to vote on a bill with just hours left this evening have begun rationalizing that they might have to extend their consideration into Jan. 1, noting that the move might have little impact during a federal holiday in which the financial markets are closed.
Talks all weekend appeared to move toward resolution on one issue after another, only to see another dispute evolve -- a reflection of both sides' attempts to produce a final deal acceptable to their caucuses in both chambers.
While Democrats now appear to have given to the point of supporting higher $360,000 to $450,000 thresholds for upper-income tax hikes on individuals and joint-filing couples, they nevertheless are reportedly seeking to raise additional capital gains revenue from all those earning above the lower $200,000 to $250,000 thresholds long identified by President Obama. Meanwhile, Republicans are still holding out for a $550,000 threshold at which top rates would rise.
Separately, though news sources had earlier reported that the Democrats would likely agree to the GOP's demand to maintain top estate tax rates at 35% with a $5 million exemption, rather than President Obama's proposal for a 45%/$3.5 million regime, the party's evolving final ask seems to be demanding more "death tax" revenue than that currently being collected. In that sense, the move appears a safety valve allowing the venting of liberals' angst about the level of give on upper-income tax levies that Democratic negotiators and the White House appear set to accept.
Key sticking points appear to involve:
- How broad the deal should be. Besides fleshing out an outline for dealing with tax rates, including renewed inflation-indexing of the alternative minimum tax (AMT), negotiators have also discussed a Medicare Sustainable Growth Rate and "doc-fee" fix, and an extension of business-tax expensing. Meanwhile, the White House has demanded extended unemployment insurance benefits and at least a one-year fix for the scheduled Jan. 2 $110 billion defense and non-defense budget sequesters.
- Whether additional spending in a deal might be offset and how it will be accomplished. Republicans have insisted that the costs generated by the fresh unemployment benefits, "doc-fee" relief and proposed sequester dodge be offset by comparably sized spending cuts elsewhere -- a demand they initially proposed to meet by forcing movement toward a chain-weighted CPI, or "diet COLA" methodology, to create savings in Social Security and other federal benefit programs. But Democrats have sought instead to offset the new costs with assumed higher revenues from the upper-income tax hikes, a nonstarter for the GOP. The issue has evolved into a highly charged and symbolic ideological fight, made even harder to bridge when Democrats seemed to use the earlier diet COLA idea to slow-walk weekend negotiations long after Republicans had withdrawn it when both sides faced the challenge of coming up with another suitable offset.
Also unclear is the duration of any final deal, i.e., whether it might extend the lower tax rates permanently or just for one year, thereby providing a natural trigger for tax reform. Meanwhile, my partners and I continue to note that perhaps the most important facet of the notionally evolving cliff fix is that it apparently would not lift the debt ceiling, which Treasury Secretary Tim Geithner announced last week would be formally reached today but can be finessed through "extraordinary" administrative actions for several weeks. Any surprise announcement of even the briefest temporary extension of the ceiling might also add support to the markets.