Federal budget woes and their impact on investments

Doug Horn

In the coming months as the “super committee” meets and works toward a recommendation, we may once again see increased volatility in the investment markets. It seems like this is the same song, only the second, no make that the fifth verse.

While the Federal budget is almost so large it is difficult to put the dollars into perspective, it still works just like the budgets we face in managing our own income and expenses. The Federal government has the same four options when attempting to balance the budget. They can increase taxes and thus increase the revenue. They can cut spending and as a result lower the deficit. They can attempt to borrow more money by issuing more bonds to pay for expenditures that existing revenue does not cover. Or, their fourth and final option is to declare bankruptcy and thus wipe out some of the debt and corresponding required payments. Naturally, I do not believe anyone expects the Federal government to declare bankruptcy. As such, the likely solution will be a blend of increased taxes, reduction in spending, and I suspect additional borrowings will still occur.

For decades the national debt has been increasing. The following table shows the government debt is in the trillions of dollars and has almost increased fourfold since early 1993. The U.S. debt has increased for the same reasons our personal debt increases; more money was spent than was received from taxes and fees.

Part of the concern is that if the amount of debt continues to rise and the economic environment remains flat, the question of the federal government’s ability to pay the debt will continue to increase and the U.S. may face additional rating reductions. The lower the rating the higher the interest rate becomes which forces the expenses to go up because more interest is being paid. If expenses go up for the U.S. government, then they will once again need to raise revenue or cut spending. Clearly, this can become a vicious cycle, especially when what is owed is more than $14 trillion.

The argument against higher taxes is that higher taxes on individuals will reduce funds available for investing and job creation. In my opinion, higher taxes on corporations are worse for the economy as corporations are not in business to lose money. Thus any higher expense, even if it is taxes, added to the cost of the product or service carries through to the general public and they pay the increase through higher prices.

The government is also part of our economy; unfortunately it has been becoming a larger share of the GDP than in earlier years. Therefore, cutting spending at the government level does not encourage job creation and does not help our economy grow.

Since higher taxes can reduce what the citizens have to spend and as such be detrimental to a weak economy, and borrowing more money when the government already owes so much could lower its rating causing it to pay higher interest costs, and spending cuts also could weaken the economy, it does not appear there is a viable or easy answer out of our budget woes. The verbal debates most likely will become heated and as always the other political party is to blame. In a similar fashion to the debates over the debt ceiling limit, the investment markets may once again experience substantial swings. While the long term outlook appears positive, these swings in market value will create opportunity for those with longer term view. But, it will also create concern for others since the investment markets could move four to six percent in either direction if doubt increases regarding the super committee’s ability to achieve its goal.

For assistance with insurance, estate planning, and managing investments, contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.

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