The United States has been standing on a financial precipice, with a variety of distinct hazards to avoid. In addition to the oft-cited fiscal cliff, there are economic, tax, political, geopolitical and earnings pitfalls to avoid as well. Shifts in positioning on the precipice, in the form of debt limit hikes and deadlocks in Congress, may keep America from the abyss for the time being, but they may nudge the nation even closer to the edge in the long run. For the sake of the collective national and global economy, the U.S. Federal Government must enact significant structural reform in a way that promotes the sustainability of its programs, spurs bipartisan harmony in Congress and revitalizes the American economy.
The Fiscal Cliff
Used loosely here, the fiscal cliff refers to the economic disaster that could occur if the U.S. government budget deficit was allowed to continue. According to the Heritage Foundation, Social Security, Medicare, Medicaid and Welfare programs comprised 62% of U.S. government spending in 2012. Republicans and Democrats alike can agree that if no changes are made, financial doom is impending; possible scenarios include rampant inflation, currency crisis and a sizable recession. No one program is to blame, and significant improvements are necessary across the board.
According to the U.S. Social Security Administration, Social Security's annual costs will exceed annual income beginning in 2021. It is also projected that the program's trust fund assets will be drawn down by 2033, resulting in insolvency. Social Security's failings can be attributed to a number of exogenous variables such as population growth, lifetime longevity and interclass income disparity. The Board of Trustees has recommended that either the payroll tax must be raised or benefits must be reduced in order to maintain the program.
Medicare and Medicaid pose an even more pressing threat; once again, exogenous variables such as rapid population growth via the baby boomers and rising healthcare costs have rendered the healthcare system unviable. While President Obama's Affordable Care Act did succeed in cutting $716 billion from Medicare spending, the solvency of the Medicare trust fund was only extended to 2024. The easy way out - cutting Medicare or Medicaid benefits - would be an unpopular decision on all accounts. Other options, such as the Independent Payment Advisory Board (IPAB), have been for the most part unsuccessful. IPAB was created to help limit Medicare spending, but it does so at the expense of the taxpayer; many doctors now refuse to treat Medicare patients as a result of low government reimbursement rates. In order to seriously address the U.S. Federal budget deficit, the American healthcare system must first be reformed.
The Economic Cliff
The overarching narrative on Wall Street and mainstream media is that we have emerged from the worst of the recession. To further this point, analysts frequently cite the increased regulation of the banking system by way of the Dodd-Frank Wall Street Reform and Consumer Protection Act. While this legislation is benefitting the economy, overhaul of the financial services industry is not yet complete.
The Dodd Frank law was enacted in 2010 and it effectively fastened a tourniquet upon the banking sector, a sector whose excesses were a major cause of the financial crisis of 2007-2008; however, some of the regulation may still be lacking in severity. For example, the "hedging exemption" stipulated by the Volcker Rule allows banks a loophole with which to engage in risky proprietary trading. Insider trading and financial fraud continue to plague the industry as a whole; at worst, banks negotiate settlement fees for their transgressions, few executives are ever legally charged for their crimes, and bank bailouts only serve to incentivize greed on Wall Street. For the American people to trust in their banking system once more, the SEC must ensure that this kind of nefariousness does not continue.
The Tax Cliff
Around the world, an increasing number of foreign nations have made steps toward progressive tax codes. France, the most notable example, recently attempted establishing a marginal tax rate of 75% for individuals earning over $1.3 million. While that rate was shot down by the Constitutional Council of France, leaders plan to propose another revised plan this year. While it is generally accepted that wealthier individuals should be subject to higher tax rates, extreme tax hikes are sure to discourage entrepreneurism and wealth creation. Indeed, the most affluent are allegedly prepared to leave France.
In America, many forget that the driver of the debate is U.S. National Debt, as the Federal Government struggles to reverse its spending ways without … well, without having to spend less. Despite reports that clearly establish the inefficacy of tax increases in turning the deficit around, progressive taxes are still seen by many as a primary solution to the debt crisis. Weighing into the debate, a broad spectrum of "trickle-down" economists, prominent businessmen, think tanks and more radical 99%-ers. In short, a more progressive tax code is all well and good at the margin, but confiscatory taxes, will wreak destruction upon the economy.
Political and Geopolitical Cliffs
The greatest political danger that the United States faces today is divisiveness. This kind of widespread dissention has become ubiquitous in American society. In fact, Republicans have called President Obama "the most divisive president in history." In the history of Congress, the filibuster was used almost 400 times between 2007 and 2012, but was only used once each year, on average, between 1917 and 1969. Political impasse has been reached. Before being able to achieve real change, politicians must strive to live up to the standards of past bipartisan cooperation.
The geopolitical cliff is merely an extension of the political one. Many areas in the United States have become increasingly politically polarized. Some have gone as far to suggest that the United States has not been as divided since the Civil War era. A cursory examination of your typical blue/red colored map denoting the most recent presidential election results will serve to prove this point. Politicians end their speeches with a reference to the enduring American spirit of rallying together when times are at their worst. Rather than becoming an over-quoted nicety, the American public must live it.
In this tumultuous economic climate, many companies are experiencing earnings weakness as a result of both macroeconomic and industry-specific headwinds. Variables such as more taxes, continued high unemployment and disproportionate income growth has stunted aggregate demand. In response, an increasing number of companies have taken to issuing negative EPS guidance previous to each quarter.
Despite these negative factors, analysts are hopeful for the U.S. economy. Variables such as shrinking household debt, rising consumer confidence and higher consumer spending rates may stimulate the economy better than any government stimulus package could. The most striking of these variables is household debt. In the third quarter of 2012, household debt fell to a 29-year low. Thus, while earnings may be declining, corporate America may be on the mend.
The Bottom Line
In sum, the United States sits on a handful of cliffs: fiscal, economic, tax, political, geopolitical and earnings. Many of the measures passed will only serve to temporarily halt the nation's march towards the edge. America must re-evaluate the functionality of its government and economy as a whole and it must do so quickly.
More From Investopedia
- The Impact Of Combining The U.S. GAAP And IFRS
- Money Can’t Buy Happiness, But What About Championships?
- 10 Biggest All-Star Bargains Of 2009