Another bag of birdshot, and Happy New Year!

Well, it's a new year and the markets around the world today have been exuberant in their response to the application of the brakes at the last possible moment before hurtling over the so-called "fiscal cliff."  

Some analysts have suggested that policymakers "played chicken" for so long before slamming on the brakes that the Senate, at least, could not possibly have even read the final agreement before they voted to approve it.  But, no matter -- what the markets are happy about today is the fact that things probably could have been a whole lot worse, in that taxes will go up (more on that in a moment) but not by as much as they might have.

As many have also pointed out, and as we would like to point out as well, the last-minute "compromise" that moved through Congress was by no means a "budget."  What the politicians in Washington hammered out was a tax package, and one that does not even pretend to address the elephant in the room, which is the need for spending cuts on the entitlements (Medicare and Social Security in particular) that in some future budget will have to be addressed (but just not yet).  In the meantime, instead of dealing with that thorny issue, we have a bit of tinkering around the edges of the tax levels, and harmful tinkering at that.

The percentage of an employee's income taxed by the federal government for Social Security now reverts to 6.2% (from a temporarily-reduced level of 4.2%), which will immediately impact everyone drawing a paycheck in 2013.  Individuals filing annual returns for 2013 showing an adjusted gross income (AGI) of $250,000 or more -- and couples filing jointly with an AGI of $300,000 or more -- will see many of their deductions reduced or eliminated, including the "personal exemption" as well as the elimination of the majority of itemized deductions available to such filers, including charitable contributions and mortgage interest.

Most significantly, the new cliff deal raises income and capital gains / dividend tax rates on individuals with a 2013 AGI of $400,000 or more, and on couples filing jointly with an AGI of $450,000 or more.  Those taxpayers will see their marginal income tax rates rise to 39.6% from 35%, and their tax on any capital gains and dividends rise to 20% from the previous 15%.  We have written before that these types of increased tax rates on investment, even if they are only enacted on "the wealthiest 2%" -- as the president described them in his press briefing minutes after the deal was reached -- can be very significant to the decision of whether to expand a business, fund a young entrepreneur with a promising innovation or new idea, or take a pass on risky investments because any increase will be taxed more heavily.  In other words, the tax rates on "the wealthiest" matter to everyone, as we explained in that previous post.

On the other hand, the increases agreed upon in this last-minute deal are not likely to be devastating, and they certainly could have been worse in many ways (the levels of AGI at which the increased taxes on investment gains might have been set even lower, for instance).  They will handicap the economy some more, to be sure, but they do not represent a reason for investors to panic or flee in terror.  They are simply another canvas bag filled with birdshot that will now be padlocked to the necks of the citizenry and hence the economy as a whole, to use the vivid metaphor created by author Kurt Vonnegut in his 1961 short story, "Harrison Bergeron."

In that disturbing tale, set in a dark dystopian future in the year 2081, the "United States Handicapper General" mandates "handicap bags" to be worn at all times by anyone who is stronger than average,  as well as a variety of other impediments to compensate for any above-average traits, including masks for those with beautiful faces, and ear implants that blast mentally-disruptive bursts of noise for anyone of above-average thinking ability.  The story can be found in Vonnegut's collection of stories entitled Welcome to the Monkey House as well as in a variety of places on the internet (here is one website where you can read it; it is broken into two pages and the second page is here). 

The fiscal cliff deal, in other words, only adds another "handicap" to the economy, along with all the others that the politicians (of both parties) have been mandating for decades, with greater or lesser degrees of negative impact (see our previous post entitled "We get by in spite" for more on that subject).  As we have written before, during times (such as this one) in which the economy and climate for growth is more dystopian than normal, investors cannot rely on the idea that "a rising tide lifts all boats," and must become even more selective in the companies in which they invest their capital.  Investors have to seek out truly exceptional destinations for their investment capital, in other words -- exceptional in the way that young Harrison Bergeron or the ballerina are exceptional, so to speak.

We wish all our readers a very Happy New Year, and welcome to 2081 2013!