Can We Hope for a Soft Landing if We Tumble Over the Fiscal Cliff?

I think so, but we’d better buckle our financial seat belts anyway, because the next few months are going to bring us a bumpy ride politically — and perhaps financially, as well.

Unless there is action in Washington, most Americans face higher taxes in 2013. Big cuts will automatically hit defense and most social programs, though a few especially sensitive items, such as Social Security, are exempt. Many economists believe the combination will reverse the fragile economic recovery and trigger a new recession during the first half of 2013.

A brief recession might not be a bad price to pay for halving the federal budget deficit, as the scheduled changes provide, but with unemployment stuck above 8 percent in an election year, leaders in both parties say they want to act in time to prevent the automatic spending cuts and tax hikes from taking effect. The coming months will bring a major clash over exactly what to do.

To complicate matters, the Treasury is again beginning to crowd the legal ceiling on federal debt. Just as in the stalemate that dominated headlines in mid-2011, it is a foregone conclusion that the ceiling will be raised, but GOP deficit hawks are likely to again use the debt limit as leverage to force deeper spending cuts than Democrats and some other Republicans want.

The action will begin in earnest on Nov. 7, the day after Election Day. Regardless of what the voters decide, President Obama will remain in office until January, and a lame-duck Congress will return to Washington to deal with a huge pile of unfinished business that includes the fiscal cliff and the debt ceiling.

Democrats will push to let the Bush-era tax cuts lapse for upper-income households. They also are likely to try to roll back the $5 million per person exemption for gift and estate taxes, and to raise the current top gift and estate tax rate from 35 percent to 45 percent or higher. Republicans want to continue the current tax rates for everyone.

A victory by Mitt Romney in November would probably ensure that the Republicans would prevail in the tax fight. The only way Democrats would be able to raise tax rates on higher-income households would be to let the Bush-era rates expire for everyone. Democrats would have the voting power, at least in the Senate, to do that, but they have shown no appetite for raising taxes on middle-income voters.

Conventional wisdom holds that an Obama victory would let Democrats win the tax-rate battle. I am not so sure. Obama likewise has no appetite for a tax increase on most American households, as he showed in his tax compromise with Republicans (in a Congress that had Democratic majorities in both houses) in 2010. Republicans will also have the debt-ceiling card to play.

I expect that an Obama victory will mean either a stalemate on taxes that will continue at least into early 2013, or some sort of tax compromise with Republicans that will extend current rates, or something close, through 2013. One exception is that higher tax rates on investment income for upper-income households, which are part of the health care reform law, are likely to remain in any compromise with a re-elected President Obama.

Tax legislation tends to emerge from lame-duck Congresses at the eleventh hour, often with provisions that have seen little or no public discussion. We are likely to be stuck with major questions about near-term tax policy until very close to the end of the year, or beyond.

I doubt that Democrats can get the tax increases they seek, but I believe affluent taxpayers should act as though all of the scheduled increases will happen until we know otherwise. A good general strategy would be to accelerate some income into 2012 to be taxed at this year’s rates, if that income would otherwise be recognized in 2013. The generous gift tax exemption also might go away, so there can be a lot of value in moving wealth to younger generations while the exemption is available.

Beyond the near-term deadlock between the parties, the campaign season has actually elicited a certain consensus about the need for a tax code overhaul and the general form it should take: lower tax rates, especially for corporations; fewer deductions and credits, especially for higher-income households; and possibly some changes in the way cross-border activities are taxed to encourage American manufacturing and exports.

A Romney victory would probably bring a relatively quick agreement to extend the status quo for a year or two while a broader overhaul is considered. An Obama victory might yield the same result. Together with a reasonably efficient resolution of the debt-ceiling extension, this would avoid taking us over the fiscal cliff altogether.

Failing that, a brief excursion into a world with higher taxes and less government spending will at least focus the nation on the reality that the current course of repetitive trillion-dollar deficits is unsustainable. If deadlock means bringing the federal budget under reasonable control, even at the price of a short-term economic slowdown, it will not be the worst that could happen.

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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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