With the 2012 elections just days away, the battle for the presidency is shaping up to be a very tight race between President Barack Obama and Gov. Mitt Romney (R- Mass.)Regardless of the outcome, the victor must cope with a sluggish economy, high unemployment and countless hot-button issues that divide the nation.
Financial markets, in particular, have been plagued by uncertainty amid muted economic growth, a protracted debt crisis in Europe and the looming US fiscal cliff. Peter Lefkin, head of government and external affairs at Allianz of America in Washington, D.C. shares his thoughts on the elections and their implications for tax policy, health care, financial services regulation and the stock market.
How will the outcome of the election impact the fiscal cliff, specifically the tax policy and the possibility of tax reform?
The fiscal cliff is the most immediate issue that Congress will face after the election. And there’s a fundamental divide between the parties on how to approach these issues. President Obama has made it clear that he will not cave to Republican pressure and will therefore allow the Bush tax cuts to expire for upper-income individuals. He’s adamant about this and it has been an emphasis throughout the campaign. Gov. Romney and the Republicans are saying all of the Bush tax cuts should be extended until Congress has had an opportunity to review more broadly the scope of the tax law. The only area of agreement, at least between the Republicans and the President, is that the temporary payroll tax holiday should expire, although some progressive Democrats are taking a different position.
In the end, Congress will likely make a number of minor modifications and allow certain taxes to be reinstated, such as the payroll tax. This is meant to assure capital markets—and perhaps even the American people—that there is a serious long-term effort underway to reduce the deficit. I anticipate that the majority, perhaps 80% of the spending cuts scheduled to take effect on Jan. 1, 2013, will be postponed. Still, it’s a thorny issue. Congress wants to demonstrate a seriousness of purpose, something that might not necessarily be believed by a public that is losing any faith they may have had with politicians. Fundamentally, there will be a plan with a short-term palliative. The message likely will be that, after the fiscal cliff, lawmakers are going to take six months to examine expenditures and tax programs and, by June, Congress will have a master plan to address these issues.
Still, US tax policy is a leviathan. The complexity of it and the cost of compliance are extraordinary. Democrats suggest that it is unfair because it favors the wealthy, who make the greatest use of its tax incentives, such as the pre-income tax deductions for 401(k) plans. Republicans argue that the tax code is too complex and makes it difficult for the US to compete in global markets. But both parties agree on one thing: Tax reform is going to be in the cards. And perhaps motivating them is not only the much-needed reform of the tax system, but also the hope that it might prove to be a relatively painless—at least politically—way to raise revenue.
What does the election portend for taxes on dividends and capital gains?
The dividend tax rate, which currently stands at 15%, will be extended until well after Jan.1, along with most of the Bush tax cuts. Taxes on capital gains and dividends will be addressed in the context of comprehensive tax reform. The consensus is that the system is broken and that the tax code is overly complicated and overly proscriptive, and needs to be reformed. Some of the proposed fixes include reducing tax rates and expanding the scope of income subject to taxation. It’s safe to say that dividends and capital gains will be on the table. However, dividend taxes being raised to the highest income level—39.5%—will not occur. Policymakers understand the need for long-term savings and the importance of dividend income for the nation’s retirees and the elderly. If it’s not extended at the current 15% rate, then it will go up marginally, perhaps close to the 20% level that existed during the Clinton Administration. It will never go up to ordinary income levels.
Crisis tends to compel action in Washington. Can we expect something similar to the TARP bill, whereby legislators strike a deal at the eleventh hour?
You’re always safe to bet that Congress is going to act at the last minute. There will be a lot of handwringing and turmoil, and they’ll probably screw it up a few times before they get it right. You’re dealing with two political parties with a fundamentally different view on how to proceed. What will motivate them are two things: the large number of jobs that might be cut as a result of sequestration, particularly in the defense industry, and the role of the US dollar in capital markets. For a long time, despite our fiscal profligacy, we have been blessed by the fact that foreign investors come to this country to purchase 10-year Treasury bonds—now with very low yields. With the euro zone facing its own difficulties and the world in turmoil, the US remains a comparative safe haven. That’s not going to last forever. US credit was downgraded in August 2011 and could face another downgrade soon. That would be extremely detrimental to markets and the economy. Congress knows that it’s a real risk and is anxious to avoid it.
The debt-ceiling issue will re-emerge in 2013. Can you talk about the concept of a “mini sequester” and what it means?
The concept of mini-sequestration has been bandied about in Washington for the last month. You have eight US senators—four Republicans and four Democrats—who are looking for a comprehensive short- and long-term solution to our deficit problems. Should Congress fail to act, roughly $115 billion in defense and non-defense expenditures would expire at the end of the year. But Congress will act. It understands that keeping these expenditures intact is important to keep the economy moving, particularly in the defense industry. There are mounting concerns that using a hatchet rather than a scalpel might have serious consequences for the US military. Congress wants to send a signal to the market and its constituents that it is serious. What you’ll probably see is a certain amount of expenditures cut without identifying any specific component of either defense or non-defense spending. Rather, it will be left up to the administration and the impacted agencies to find those savings.
Not only does the presidency hang in the balance, but also Senate and House seats are up for grabs. What are the most likely scenarios for partisan control in Congress? What are the implications of each?
It’s going to be very tight regardless of what occurs. There are about seven or eight seats in the Senate that are in play. This does not look like a “wave” election like the last three elections. And so the most likely scenario is a statistical one. The seats will be roughly divided. Coming off their 2010 results, Republicans, anticipated—as recent as four months ago—that they would pick up about five seats to bring them into a majority with 52 seats. Their expectations have been diminished through a combination of surprisingly good Democratic candidates in Republican seats, and, in some instances, terrible Republican candidates in places they should win with relative ease.
A Democratic-controlled Senate will probably mean business as usual in Washington. The last two years have seen Republicans come forth with a number of proposals, but none have been seriously considered. Should the Republicans take control of the Senate, there is no guarantee that the bills they’re sponsoring would pass, but they would at least be considered. You’ll likely see major modifications to Dodd-Frank and the Affordable Care Act if Republicans take control. But the majorities will remain small. Republicans will not achieve a repeal of either law, but stand a better chance of challenging a few select provisions.
In your experience in Washington, how much do the election results impact markets and the economy? Is that any different in 2012?
It might be different this year because so many people are paying more attention to the markets than they have previously. The last time you had a major market response after the election was in 1980. And that was driven by confidence in President Reagan and a very serious effort to address inflation, which was plaguing the nation at that time. It ultimately propelled the tremendous bull market from the 1980s to the 1990s. I don’t think the results of this election will have as much of a short-term impact on the markets and the economy for three reasons:
What does the outcome of the election mean for financial regulation, specifically Dodd-Frank?
- Republicans currently control the House of Representatives and already have a fairly significant amount of influence. A Republican president would change things, but not dramatically.
- So much of the markets are really a confluence of price-to-earnings ratios and corporate earnings. I don’t think the election really matters as much as the fundamentals.
- The global financial situation is largely beyond the control of the US government. Interest rates and the fate of the euro remain unknown.
Obviously, there are fundamental differences between the parties. Dodd-Frank had almost no Republican support when it was enacted. Republicans made repealing the legislation one of the major elements of their political platform. But governing and campaigning are two different things. There will never be a serious effort to repeal Dodd-Frank. It simply will not happen, even if Romney gets elected. There are enough votes in the US Senate to block debate. You are more likely to see an evaluation of various components of the law to determine if they can be significantly modified.
What about health-care legislation?
There will be no repeal of the Affordable Care Act. Regardless of the election outcome, the majorities in both houses will be small. Democrats should be able to block any significant efforts to repeal the law. Republicans will try to fine-tune the law, limit its application and defund certain provisions while trying to leave in place things that people like—mandatory access to private insurance, for example. This allows adult children to stay on their parents’ health-care plan until age 26.
The Republicans will have success in the margins. The real battle will be on the individual mandate, which Republicans and even some Democrats oppose. However, if the Republicans prevail here, it would create major problems for both health-insurance companies and medical providers. Many of them are counting on the additional revenue. Many of them would have a hard time implementing the universal-access requirements because many individuals might wait until they are sick before buying insurance. The issue for the nation’s health-care system: Can you modify a law that isn’t really working well to begin with? And if you modify it further, is it going to make it that much more dysfunctional? That’s a difficulty the health-care insurance industry will have to confront.
The election is a tight race at this point. What is the biggest swing factor for undecided voters?
The American people are evenly split because there is a true divide in the two parties’ philosophies on government. Both political parties have done what they do best: mobilize their supporters and generate excitement. Now, at the last minute, they are trying to make their play to political independents who, ultimately, will determine the winner. For many Americans, it’s not about the likability of the candidates or whether they’re “better off than they were four years ago.” It’s about whether or not they believe the nation is on the right track. Whoever wins the election will win it on that basis. President Obama argues we’re moving in the right direction. Gov. Romney argues we’re not. This slugfest is going to come down to the wire. As a result, both political parties will be spending the next four days trying to make sure their supporters vote.
Many political observers believe that the outcome might be determined by the central suburban voters in larger cities in these states: Ohio, Wisconsin, Colorado, Virginia and Iowa. People in these areas voted for President George W. Bush fairly convincingly in 2000 and 2004, but they shifted to President Obama in 2008. They are clearly now up for grabs.