Hang gliding over the fiscal cliff

When George W. Bush took office in January 2001, he fully intended to set out on being the ‘domestic president.’ He wanted to build the economy and internally strengthen America. When September of the same year rolled around, all bets were off. Thus, the presidency of George W. Bush has been remembered primarily for quite the opposite: foreign affairs. Wars, peace talks, summits, challenges, compromises, and death threats were the norm of 43’s presidency. So, it is easy to forget about what Bush did stateside—and no, it was not inconsequential.

At the beginning of Bush’s presidency, he led the way in introducing key tax cuts that stimulated economic growth that have lasted a decade’s time. The problem with this huge reform is that it is not permanent—the cuts are set to expire at the end of the current year, substantially increasing taxes—thus the term, fiscal cliff. This is a bit misleading as the effect is not entirely immediate, but the effects will begin to be felt immediately. The reason the concern is rapidly turning into a panic has to do with arguably the largest reversal if tax cuts in the whole gambit: dividend taxes and capital gains taxes.

Currently, both dividends and capital gains are taxed at a rate of 15%. If the cuts expire, these will both rise to 35%. A 20% increase in taxes on dividends and capital gains would be crippling. There is little getting around that this increase in taxes would send the fragile U.S. economy back deeply into recession. The long-term economic effects are unfathomable and foreboding—there is no telling how much it will keep investors from using those valuable dollars to grow the economy and how much it will scare them about the investing future of the United States. Besides the fact that it will reduce short-term investment likelihood because of the substantial declination in returns for investors, the long-term effects are even more frightening.

No matter how you look at it (or want to look at it), the fact remains: investors park their cash where they can make the most (highest return on investment) and lose the least (lowest volatility, and, usually more importantly, lowest taxes). This fact is almost always disregards other factors, as all relevant components to investors are included in the two measures. This means that the name “United States” means nothing without the stability and profitability that comes with it. If a more stable and less restrictive financial environment pops up and has the label “China,” “India,” “Hong Kong,” or “Singapore” attached to it, investors will not blink when swiftly transferring there economy-building funds to said country.

It is absolutely essential this does not happen. Even if the president is dead-set on eliminating these tax cuts, simply letting them expire would spell certain doom for the U.S. economy. The only way to ease off of the tax cuts, if that is what the president wants, is to slowly ease off of them.