Editorial

Keep clients' powder dry for now

Nov 11, 2012 @ 12:01 am

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The presidential and congressional elections clarified some issues for financial planners, investment advisers and their clients but left dark clouds of uncertainty hovering over major financial and economic concerns.

The re-election of President Barack Obama confirmed that the tax increases in the Obama health care reform law will go into effect next year. The first of these is the 0.9% Medicare surtax on wages in excess of $200,000 for individuals and $250,000 for married couples, along with a 3.8% Medicare tax on the investment income of these people.

Because the latter tax applies to pretax income, these increases are equivalent to increases in the income tax rate of between 2% and 8% for those affected.

Also, the ability to deduct itemized medical expenses will be limited to expenses greater than 10% of income, up from 7.5%, increasing the taxable income for many people.

The tax on dividend income is going up. Now taxed at 15%, dividends may be taxed at ordinary income tax rates if Mr. Obama has his way. Dividend stocks took a hit the day after the election.

DODD-FRANK PERSISTS

The Obama victory also means that the Dodd-Frank financial reform law won't be amended, and the process of drafting the regulations will go ahead, with negative effects on banks likely as their regulatory costs increase and their profit margins narrow. There may be mergers among small banks, which will be hard-hit by some of these regulations.

It is over the huge issues of the fiscal cliff, the broader income tax increases sought by Mr. Obama and the possibility of major structural reform to improve the efficiency of the tax system — and how the huge federal deficits and the burgeoning national debt will be addressed — that great uncertainty still reigns.

Yes, he won the election and can claim that the nation approved his policies. But House Republicans, which remain the majority, likewise can claim that their voters approved of their efforts to cut federal spending.

Virtually all 29 GOP House members elected in 2010 with Tea Party help were re-elected. To be sure, Congress typically sees significant turnover in midterm elections rather than presidential elections, as it did in 2010 in favor of the Republicans and 2006 in favor of the Democrats.

But Republicans are unlikely to see much reason to surrender to Mr. Obama's proposed tax increases, especially as he speaks of investing (i.e., spending) a portion of any revenue in education, infrastructure, etc., rather than using it all to cut the deficits and pay down the debt. The question is whether Mr. Obama can make an offer on spending cuts attractive enough to win tax concessions from the House GOP.

The do-nothing Senate, which hasn't passed a budget in three years, remained in the hands of the Democrats with a slight gain, but not enough to give them a supermajority, so it remains largely irrelevant in the fight over spending and taxes.

Businesses are unlikely to make big spending decisions while the tax picture is unclear. As a result, the economic recovery may well remain weak for many more months.

And as the stock market abhors uncertainty, it is unlikely to provide strong returns until that cloud of indecision begins to lift.

Other than paring back clients' positions in dividend-paying stocks, advisers can do little to prepare them for whatever comes from the fractious negotiations over the country's financial issues.

They are best advised to keep clients' powder dry and not make any major strategic moves in their long-term plans until the issues are thrashed out between the White House and the Congress, and a resolution is in sight.

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