The US equity market is going to surge at the start of trading following the news that Congress passed a deal that averts the full force of falling over the fiscal cliff. Still, the deal that was crafted in another silly, eleventh-hour compromise is devoid of any spending cuts that are an essential component for getting the deficit under control.
The main provision of the deal calls for the income tax rate to go up to 39.6% for individuals making more than $400,000 a year and households with a combined income of more than $450,000. The lower tax rates below those income thresholds will be made permanent. Other provisions include:
- A bump in the capital gains and dividend tax rates for high-income earners from 15% to 20%
- A one-year extension of unemployment benefits for the long-term unemployed
- A two-month delay in the $109 bln sequestration, which forced discretionary and non-discretionary spending cuts
- A permanent fix for the alternative minimum tax
- A 40% estate tax (from 35%), with the first $5 mln exempt for individual estates
- A one-year deferral of a 27% cut in Medicare payments to doctors
- A provision that allows businesses to write off 50% of new investments immediately
It is estimated that $600 bln in new revenue will be raised over 10 years.
The S&P futures are up 26 points and are trading 1.8% above fair value. Many markets in Europe are up better than 2.0%.
Bonds are getting clobbered. The 10-yr note is off 25 ticks, sending its yield up to 1.85%. The US Dollar Index is down 0.5%.
Unfortunately, it ain't over yet in Washington. The debate over spending cuts is going to heat up -- and soon -- with the debt ceiling hanging ominously over Capitol Hill. It is not expected to be a pretty fight.
The strong boost in the futures market this morning reflects a sense of relief that the tax deal should help keep the US economy from slipping back into recession. Still, it seemingly ignores the fact that the tax deal, which did not include an extension of the payroll tax cut, is going to be a drag on the economy.
In effect, income tax rates did not go up for the middle class, but workers in the middle class, and all classes for that matter, will be taking home less in their paycheck this year as the Social Security tax reverts back to 6.2% from 4.2%. For a worker making $50,000 a year, that translates into a $1,000 tax hit.
Separately, with Congress basically punting on the hard work of spending cuts and entitlement reform, and doing so in a very acrimonious way, the risk of a credit rating downgrade for the US remains real.
These important points may be lost on the equity market for the time being, which lives for the immediate gratification of the senses, yet they could come back around to haunt the market if the new Congress sworn in tomorrow embraces the same path of partisanship that leads to silly, eleventh-hour compromises that are anything but a comprehensive solution.