In our view, the year-end fiscal challenges in the US are more like an “obstacle course” than a “cliff”-politicians must navigate about 10 major policy decisions before year-end (Table 1). More than three weeks after the election and they are still stuck at the first obstacle: the role of taxes in any deficit reduction agreement. What is the hold-up here? Isn’t there an easy deal that focuses on capping deductions? After all, both parties have been talking about this approach as a way to raise taxes on the wealthy without raising tax rates.
We see three reasons why it is proving very hard to overcome this obstacle:
1. There is a very big gap in the starting point for negotiations.
2. The results of this negotiation could set the tone for future deals.
3. On the surface, capping deductions looks like a painless way to raise revenues, but it looks quite ugly upon closer inspection.
As we have been arguing for more than a year, we expect a messy multi-stage deal on the cliff, with a partial deal in late December and a full resolution only in the Spring. During this period, we suggest that investors fade the likely “press fakes” of an imminent deal, and brace for downside volatility.
Read the full report here.