Uncertainty Stemming From Our Political Problems

A few days ago, CNBC highlighted a client note by Goldman Sachs strategist David Kostin about the fiscal cliff. In short, he advises them to be wary of the cliff and be ready to sell assets before it hits.

This is a natural short-term reaction, since the top capital gains tax rate will rise from 15 to 20 percent and an additional 3.8 percent tax will be imposed starting next year; in addition, short-term capital gains (those held for less than a year) are taxed at ordinary income rates, which would also rise. As has happened in the past, if there is a scheduled capital gains tax increase, investors move to realize gains just ahead of the deadline to reduce capital gains taxes.

The more important point is not this reaction, but rather that Kostin is very seriously considering the possibility that Congress will not act at all. As he said, "Political realities and last year's precedent suggest the potential that Congress fails to reach agreement in addressing the fiscal cliff is greater than what most investors seem to believe based on our client conversations." This statement fits in with the building narrative that the inability to come to a politically feasible solution is increasingly causing people to doubt whether lawmakers will in fact avoid the cliff at all or act in a responsible manner.

And who can blame him? So far, the only formal action in Congress has been votes on unpaid-for one-year extensions of the 2001/2003/2010 tax cuts and the Alternative Minimum Tax patch that have only passed one chamber. In other words, the only action so far has been fiscally irresponsible temporary tax cut extensions that have no chance of being passed into law. Not exactly cause for optimism.

But there is still time. Lawmakers must get serious in September and beyond about a plan that avoids the fiscal cliff and the mountain of debt that would result if we simply averted the cliff without offsets. A task this important cannot wait until the last second.