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Market Commentary

The Taxpayer Relief Act-a misnomer to celebrate the swearing in of the new Congress
January 03, 2013  David R. Kotok, Chairman and Chief Investment Officer

"OMB head Jeff Zients complains that the CBO analysis is not realistic. In OMB's view, we were not really going to go over the ‘cliff.’ Zients points out that the ‘Act’ actually reduces the deficit $737 billion. This savings is achieved by making a ‘current policy’ assumption as the baseline. What is that? Current policy, according to a variety of footnotes, assumes the Bush tax cuts, the AMT patch and business tax provisions would be extended, that the Medicare physician cut will not take effect and that sequestration would not be put into place. Of course, this approach dramatically widens the deficit. From this higher baseline the ‘Act’ shaves down the deficit modestly. The largest component of these ‘savings’ is due to the higher tax rates to be paid by the above-450,000 (joint-filing) set, the higher capital gains taxes (20% now; up from 15%) and higher estate taxes."  – Natalie Cohen, Wells Fargo

Thank you, Natalie.  You speak the truth.

Cumberland has obtained a private copy of a Senate staffer briefing memo.  It includes the CBO scoring.  It is the type of document that was employed in this debate.  It is 16 pages long. Rest assured that few if any of the Senators or Congressman read the entire bill.  The briefing memo is posted on our website, www.cumber.com , in the Special Reports section.  The title is "12/31/12 Summary of final deal Tax Document."  It is enough to make one sick.  Email me if your software cannot open it and I will send it to you.  Here is a link: http://www.cumber.com/content/special/123112taxdeal.pdf .

Now let me be blunt.  This "Taxpayer Relief Act" is a bunch of _ _ _ _!  No one got relief except the pork-receiving, politically connected “special interests.”  As for the rest of us, in fact, this is one of the largest tax hikes in American history.

In our firm of 28 people, everybody's taxes went UP.  Mine did, as I expected.  My top rate is now 39.6%, and 3.8% is added to taxes on my investment income, except for my tax-free Munis.  My long-term cap gains rate is 23.8%.  So be it.  The taxes on the higher incomes in our sub-S incorporated firm are enough money to hire several new people.  If business growth is good enough, we will hire them anyway, but the government policy has carved no exception for small business.

I only wish my government didn't squander the money.  But they do.  And they lied to me.  Nothing new here, either.

Now to the “meat” of the Congressional failure.  The 2% payroll-tax hike (because the previous reduction was not extended) hits every working person.  140 million Americans pay this on their EARNED INCOME.

Sadly, the pork in the legislation remained.  Moviemakers and auto racers and many others kept their special tax breaks.  The system remains sick.  Hollywood yes, but my $60,000-a-year employee has a $1200 permanent annual tax hike taken directly from her paycheck.

Shame on the politicians who govern us.

Markets celebrated, as one would expect.  The uncertainty premium is impossible to measure, but it is there.  Estimates are crude, but they show it is high.  It peaked a few days ago and when there were reports of an impasse to the House vote.  Now, it is shrinking.  So markets are rising after the law is passed and the new rules are known.  And the brackets are permanent.  The estate tax is permanent.  The AMT fix is permanent. 

We now have two legs of a three-legged stool:  (1) Monetary policy is predictable for several years, and there will clearly continue to be a low interest rate worldwide for both short- and long-term debt.  Global total sovereign debt issuance will actually shrink for the first time in many years.  (2) US tax rates are predictable.  Cap gains rates, income tax levels, and estate tax thresholds are set.  It is hard to see them changing over the next two years.  The Republican majority in the new House will not allow it.  (3) America’s debt and deficit levels remain to be hammered out in tough negotiations with the new Congress and re-inaugurated White House.

These politics will not be fun to watch.  In fact, the 2014 mid-term congressional races have already begun, and the antagonists are barely sworn in.  That is our system and this is the way we do it, whether we like it or not.

Meanwhile, global stock markets are headed higher.  We have written about the whys and wherefores repeatedly.  Now we can add that the risk of a fiscal cliff-induced recession is eliminated.  That is a bullish development.

We will stick with our slow-growth, gradually accelerating recovery forecast for the United States.  We like the housing sector recovery and the energy sector growth.  We remain fully invested in our ETF accounts.

And we like tax-free Munis.  The tax-equivalent-yield computation makes them even more compelling after the so-called "Taxpayer Relief Act" has become the law of the land.

David R. Kotok, Chairman and Chief Investment Officer

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