The Super Committee’s Failure isn’t an Epic Fail
Posted by Michael Bradley, CFA on November 23, 2011 ·
Shocker: The two parties couldn’t agree on a package of tax increases and spending cuts….
We are not a tax-cutting committee, we’re a deficit-reduction committee.
- Sen. John Kerry (D-MA)
The big divide was over the Bush-era tax cuts. There was stiff opposition to rolling back the EGTRRA and JGTRRA cuts of the 2000s. The super committee paired some strange bedfellows among Capitol Hill legislators, so this head-butting was not unexpected.
What happens now?: Not much, maybe cuts to non-entitlements – maybe
As the super committee failed to create a plan to trim $1.2 trillion or more from the federal deficit, that sets things up for an automatic $1.2 trillion in cuts effective over a 10-year stretch beginning January 2, 2013. According to the Budget Control Act passed in summer 2011, that $1.2 trillion will be slashed almost 50/50 from the defense budget and government services programs. Social Security and Medicaid payments, military pay and veteran’s benefits will be exempt from cuts; current Medicare recipients will not be directly affected. This default deficit reduction could mean as much as a 9.3% cut to some federal programs, by the estimate of the left-leaning Center for Budget and Policy Priorities.
Is another downgrade ahead?: It’s unlikely
Standard and Poor’s cut the U.S. credit rating a notch to ‘AA+’ on July 14, and it warned that another cut to ‘AA’ was possible by mid-2013 without decisive federal action on the issue. After the super committee conceded defeat on November 21, S&P, Fitch’s and Moody’s stood pat regarding a possible downgrade.5,6
What might be in store for the market?: It’s not good
In a November 21 note to investors, Goldman Sachs equity strategist David Kostin warned that the S&P 500 could potentially correct to 1100 as a result of this gaffe. Other analysts are less gloomy; some feel that the market may have priced this one in and will at least maintain some momentum barring a second downgrade (Monday’s selloff certainly could have been worse).
Tax increases seem very likely
The Bush-era tax cuts are set to expire at the end of 2012 as part of the involuntary deficit reduction now set to occur. There could be other possible tax consequences as a result of the super committee’s failure. Unless Congress unexpectedly passes the President’s American Jobs Act, the payroll tax holiday will go away in 2012 (worth about $935 to the average worker, which some legislators wanted to make permanent).
For businesses, the current “bonus” depreciation write-offs for new capital equipment and the R&E tax credit could also become casualties. Additionally, when you do a broad cut to federal programs, you are impacting payments from Washington to state programs; state taxes could rise to compensate for that lost money.
Effects on Government Benefits: Jobless benefits will decline, entitlements unlikely to be effective
While Medicare recipients won’t be bitten by the default deficit reduction, payments to Medicare providers could be shrunk by 2%. Long-term unemployment insurance would also dry up for 2.1 million Americans by February, according to the Department of Labor’s forecast; JPMorgan Chase economists think that development alone might hurt U.S. GDP by 0.75%.
The Social Security Administration is in line for budget cuts as a result of the super committee’s indecision, along with Head Start and federal job training programs. A Congressional Budget Office analysis shows that the Pentagon would face the largest cut in 2013 (10%). (We are, however, intending to retain our positions in Lockheed Martin [LMT]). Federal agriculture, environmental and education programs would face cuts of approximately 8% starting in that year.
Congress will likely intercede
President Obama is emphatic that there will be no rewind on this one. While there could be a move in Congress to try and nullify or alter the automatic budget cuts, the President has indicated he will veto such a bill. However, it seems unlikely given the notions of the administration.
We feel that the likely short term impact on the markets is negative, although blunted by lowered expectations. Ultimately, this reinforces the hard reality that we’re not looking towards any progress on tax or spending policy until after the 2012 elections. In the short term, expect a lot of compromises that pin all hopes on electoral victory in the immediate term.
