Politics, Taxes and the Markets

One of the most engaging speakers at last week’s Schwab IMPACT conference was Andy Friedman, who offered some provocative predictions about next year’s elections and what we can expect from the deficit super committee.  

Alec Phillips

Alec Phillips

Friedman, whose firm, Washington Update, provides political analysis focusing on how various outcomes will affect advisors and investors, was paired on a panel discussion with Alec Phillips, US economist at Goldman Sachs.

Andy Friedman

Andy Friedman

The two discussed a range of current issues and pending legislation, and I will focus on a few highlights: the likely outcomes for deficit reduction, the super committee, taxes and the 2012 election.

Solving the deficit impasse

A single issue has consumed political debate this year, Friedman said: the federal budget deficit.  At the end of this year, he said, we will not have addressed any of the key issues – entitlements and taxes – and we will have cut the deficit by only $2.1 trillion over 10 years, which is $210 billion annually out of a $1.3 trillion annual deficit.

“The fact is that we will have done nothing at all,” he said.

Friedman predicted earlier this year that nothing will happen with respect to the deficit until a crisis occurs.  At the time he said he could think of three such forcing events: a downgrade by one of the major rating agencies, China threatening not to buy more Treasury bonds, or heightened volatility, such as multiple moves of 500 points in the equity markets. 

All three have happened, he said, but nothing budged with respect to the deficit.

“This tells me I grossly underestimated the tenacity of Congress to do nothing at all,” Friedman said.

Now, the prospects for deficit reduction are in the hands of the Joint Select Committee on Deficit Reduction (better known as the "super committee"), which is charged with cutting at least $1.2 trillion from the deficit through some combination of spending cuts and revenue increases.

Phillips expects to see something close to the $1.2 trillion target, but he was less optimistic that it will represent true deficit reduction.  Some of the cuts will come from tax increases, he said, but the net may not help the budget.