How the Compromise Affects Taxpayers … and the Economy**

With a fiscal cliff compromise just signed by President Obama, investors breathed a sigh of relief yesterday, bidding up stocks over 2 percent and sending bond yields up. The bill, H.R. 8: American Taxpayer Relief Act of 2012, covered many provisions of the tax code, but the major changes that high-income Americans will see in 2013 compared to 2012 include:

  • A top income tax rate of 39.6 percent for individuals above $400,000 and for those with joint taxable income over $450,000
  • A permanent Alternative Minimum (AMT) patch. The exemption amounts are now $50,600 for individuals and $78,750 for households, and indexes the exemption and phaseout amounts thereafter
  • A top capital gains tax and dividend tax of 20 percent for income above the same amounts listed above
  • Phaseout of exemptions and deductions for adjusted gross income above $250,000 for individuals and for those with joint taxable income over $300,000
  • Expiration of the payroll tax cut, increasing the payroll tax rate by 2 percent on the first $113,700 of income
  • The $5 million estate, gift and generation-skipping transfer tax for individuals and $10 million for households is now indexed to inflation, but sets the top estate tax rate at 40 percent

These tax increases, combined with the sequestration spending cuts to take effect on March 1, will result in a roughly 1.5 percent hit to GDP in 2013. Despite this austerity, the federal budget will still run in the red, increasing the U.S. national debt level. While the cliff crisis has been temporarily averted, politicians will deal with the sequestration budget cuts and debt ceiling limit over the next two months. The drama is definitely not over.

Even though GDP growth will be below long-run trend, the austerity measures may be coming at a relatively good time. With the housing market turning as well as oil and gas spending ramping up, economic growth should still be able to post 1 to 2 percent in gains. Corporate profits should therefore remain healthy, potentially resulting in gains for equities. Besides the political drama, our main concern in 2013 will be consumer spending. With the expiration of the payroll tax and the increase in taxes on higher incomes, the federal government is taking money out of consumers' pockets. Against this backdrop, the Federal Reserve continues to keep the financial system awash in cash, which should continue to provide some monetary stimulus in the face of fiscal austerity.

While interest rates are trading at the higher end of their recent trading range, we still believe rates will remain lower, longer due to slow economic growth and continued Fed stimulus. We will continue to maintain our bond positions while Washington still grapples with the remaining “cliff” issues on the table.

**Any tax information in this communication is not intended or written by Ferguson Wellman Capital Management to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing or recommending to another party any matters addressed herein. And advice in this communication is limited to the conclusions specifically set forth herein and is based on the completeness and accuracy of the stated facts, assumptions and/or representations included. In rendering our advice, we may consider tax authorities that are subject to change, retroactively and/or prospectively, and any such changes could affect the validity of our advice. We will not update our advice for subsequent changes or modifications to the law and regulations, or to the judicial and administrative interpretations thereof.**

The information provided herein is for educational purposes only and should not be construed as investment advice or as an offer or solicitation. Not all securities are suitable investments for all investors; therefore, Ferguson Wellman Capital Management will not necessarily implement any particular strategies discussed herein for all clients. We recommend that you discuss questions regarding your individual portfolio and investment strategies with your portfolio manager.