Well folks, a deal to avert the fiscal cliff has been struck and, at least for today, investors are celebrating. Not surprisingly, the deal is flawed, but it is better than no deal at all. And the resolution, if it can be called that, proves one thing. Politicians will wait until the very last second before doing something. In this case, they waited even a little longer.
The big news is that tax rates will not go up as much as they would have gone up if no deal had been reached. But the fact that rates are going up at all is not good news. The top income tax rate (singles earning more than $400,000 or couples earning more than $450,000) goes from 35% to 39.6%. However, due to limitations on exemptions and deductions, it effectively goes well above 40%. The top rate on dividends and long-term capital gains goes from 15% to 20%. But due to a new health care related tax on investment income, it actually goes up to 23.8%. Working people making modest amounts of income, even those who pay no federal income tax at all, will see a significant increase in payroll taxes. And let's not forget the 2.3% excise tax (i.e., a tax on sales, not income) that will hit medical device makers.
If there is one thing we know for sure it is that taxes affect behavior. If you want less of something, all you have to do is tax it. Cigarettes provide a great example. Many states jacked up taxes on tobacco for two reasons: They wanted to raise revenue and they wanted people to smoke less. In fact, what happened was that so many people gave up smoking that revenues fell well short of targets.
Nonetheless, the fiscal cliff deal that passed both the Senate and House was about the best we could hope for at this time. Investors are right to celebrate today by driving up stock prices. Unfortunately, the rally may not last. After all, Congress didn't really do anything to address spending. In just a few short months we'll be facing more crises as we approach the debt ceiling and the sequester (i.e., mandatory spending cuts). Furthermore, as all adults in Washington know, entitlement reform is the only way to get this country back on a path toward fiscal responsibility. That means Medicare and Social Security. After all, there is no point worrying about a leaky toilet if your house is also infested with termites. Washington needs to focus on the big things that really matter.
Finally, I'll call your attention to a recent mention in Investor's Business Daily. I was asked to name my favorite exchange-traded fund for 2013. Thanks to low fees and a big exposure to Apple, I picked the Vanguard Information Technology ETF (VGT).