Any bid for the Presidency of the United States, from the tight race to the outcome, will surely affect both the U.S. economy and the capital markets at large. The 2012 election is no exception.
Follow our blog series for regular updates on the election and how each candidate’s strategy could impact the markets.
Today’s post focuses on Fiscal Cliff and Simpson Bowles FAQs.
President Obama and Governor Romney aren’t the only ones piling on the miles traveled in the weeks leading up to the election. My travel conditions may be less plush and my appearances aren’t met with as much fanfare, but the concerns I hear from the American people are consistent with those expressed at political rallies across this country: Americans want economic growth and credible budget reform.
David Walker, the former U.S. Comptroller General, used to talk about the nation’s looming debt crisis as the “dirty little secret everyone in Washington knows.” Well, that secret is out of the bag. We Americans want to know that our leaders have a plan to prevent $600 billion in spending cuts and tax increases from hitting at the beginning of 2013, while at the same time working together to construct a grand bargain for longer-term fiscal consolidation. There is optimism on the former, but on the latter skepticism is high.
Q: Will they prevent the country from going over the fiscal cliff?
Most investors believe that there will be a short-term deal to prevent a fiscal cliff in the lame-duck session of Congress, regardless of the outcome of the elections. I suppose the old adage applies that Americans always do the right thing after exhausting all other options.
The base case election outcome according to Intrade.com, an online trading exchange website where members bet on the outcomes of future events, is that there will be no shift in the current balance of power. That is, Obama reelected, Democrats control the Senate, and Republicans control the House. A naysayer could argue that such an outcome could create a dangerous stalemate with both sides claiming a mandate and a disaster for the markets and the economy. I disagree with this premise. In the event of a split government, I believe that both sides would have a number of reasons for coming to the table, however reluctantly. For example, if I’m a Tea Party member of Congress, the last thing I want is a huge increase in taxes, severe cuts to defense spending, but no changes to entitlement programs. I’m probably ready to compromise. If I’m President Obama, I’m willing to compromise in order to prevent tax increases on the middle class, to cement a deal to raise the debt ceiling and to avoid a recession in the first few months of my second term.
The next most likely election outcome is a Republican wave election, with Romney firing up the electorate enough to bring the Senate along to the Republican side as well. A short-term deal to prevent the fiscal cliff under such a scenario could be difficult in the lame-duck session—would President-unelect Obama sign legislation to make President-elect Romney’s life easier?—but I would expect Romney to extend the most severe components retroactively and use his first 100 days in office to attempt to pass a major budget package. As I’ve said before, investors should prepare for some market volatility as these pieces sort out.
Q: Is Simpson-Bowles the framework for a Grand Bargain?
Simpson-Bowles is a starting point. The bipartisan commission has provided the framework for cutting discretionary spending, fundamentally reforming the tax code and strengthening the solvency of Social Security, among other things. Simpson-Bowles will not be the end result. There are reasons why President Obama and House Speaker Boehner walked away from it at the 11th hour. For one, the commission was constrained to using as a starting point a budget proposed by President Obama that called for an additional $1 trillion more in revenue over 10 years. His budget at the time called for the expiration of the Bush tax cuts and limited tax deductions for the wealthy, as well as tax hikes on corporations and carried interest. Second, the commission lacks any fundamental reform of Medicare or Medicaid and leaves unaffected the Affordable Care Act. And third, the plan calls for $785 billion in tax revenue by lowering tax rates and broadening the tax base. It is not clear how these numbers add up.
We applaud the efforts of the Simpson-Bowles Commission and welcome the deep debate on what had previously been third-rail issues like Social Security and tax reform. The Grand Bargain, if enacted, will entail the framework imparted by Simpson-Bowles but, as always, the devil will be in the details.
Read more from the series Election Insights 2012 at http://blog.oppenheimerfunds.com/tag/election2012/