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Will Resolution of the Fiscal Cliff Squelch Consumption?

January 25, 2013

2013 Tax increases will not hit consumption as many fear.
-Paresh Upadhyaya, director of currency strategy, Pioneer

The U.S. averted the Fiscal Cliff with passage of the “American Taxpayer Relief Act of 2012” on December 31. Economists think resolution of the Fiscal Cliff will lead to a fiscal drag of 1% on GDP and adversely affect the mainstay of the economy: the American Consumer.

We’re not convinced this will happen and believe tax increases overstate the related negative consumption impacts. While we expect some weakness in consumption, it is likely to be transitory and confined in the first half of 2013, before recovering above-trend in the second half.

Key elements of the Fiscal Cliff resolution:

Before moving to the crux of my analysis, let’s review the central parts of the Fiscal Cliff resolution.

  • Permanent extension of the Bush tax cuts for taxable income less than $450k
  • Reinstates top 39.6% rate on taxable income above $400k for single filers and $450k for joint filers
  • Capital gains tax raised to 23.4%
  • One-year extension of emergency Unemployment Insurance benefits
  • Expiration of payroll tax holiday
  • Permanent AMT patch. Increase exemption amount and indexed to inflation
  • Permanently sets rate at 40% and $5 mil exemption per spouse indexed to inflation

 

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