Note: This article was originally published on September 29th.
As I write this it appears that the impasse over the budget will not be resolved in time to avoid a government shutdown sometime next week. I suppose it is possible that a deal gets done in time to avert what seems inevitable right now, but our fiscal troubles run far beyond the current fight over the continuing resolution. The fact that the argument is over a continuing resolution actually tells us more than anything about the fiscal fight. This isn’t a fight about an actual budget. Congress hasn’t passed one of those in a long time. And it is a bipartisan affair since it takes both the House and the Senate – controlled by different parties – to pass one. Like most Americans I am disgusted with the entire process. I don’t want to write about it or think about it and it shouldn’t be something that I have to worry all that much about as an investor.
Unfortunately, that just isn’t the case so we have to consider the impact of this latest budget and debt ceiling debate on our investments. Obviously, if the government shuts down there will be an impact on the economy and therefore on the markets. I would point out though that what we are really talking about here are the discretionary portions of the budget. No matter what happens the mandatory portions – Social Security, Medicare, Medicaid, etc. – will be funded and continue to function. A shutdown would certainly be disruptive and inconvenient but the effect on the economy is hard to quantify. Frankly, we might find that there are portions of the discretionary budget that no one misses and that, in the end, might be a good thing. I’m of the opinion that the federal government is doing way too much anyway and if a shutdown reveals some areas that we can cut then we’d be better off for it.
The debt ceiling debate is different though. A failure to raise the debt ceiling could touch even the mandatory portions of the budget if new debt is required to fund them. We will not default on our existing debts as those payments would – or at least I hope so – be prioritized above anything else. In any case, I don’t think we’ll get to that point but if we do the market is going to react harshly to such a development since the impact on the economy would be much greater. I don’t know what compromise will be reached but I am confident that one will. Neither side of this political debate will come out looking good if we reach that point. There is a cottage industry of trying to figure out which party would benefit from a stalemate but I’ve got news for the politicians. Americans are fed up with both parties and all of you will suffer if a deal isn’t struck.
Personally, I think a reasonable group of Americans should be able to come up with a budget that is closer to balanced and makes sense. Unfortunately, the Americans who occupy the corridors of Congress don’t appear reasonable. Just to pick one example, consider the effect on the US economy of our dysfunctional corporate tax. Last week Applied Materials, Inc. (NASDAQ:AMAT) agreed to merge with Tokyo Electron. The new company, a combination of an American company and a Japanese one, will be incorporated in neither. The new company will incorporate in the Netherlands. Why? The corporate tax rate in the Netherlands is 25% versus 35% in the US and even higher in Japan. The combined company expects to pay an effective rate of 17% versus the 27% that AMAT pays today in the US. With a combined revenue of over $12 billion, a 10% change in the tax rate is a big deal. From a budget perspective, changing the corporate tax to be more globally competitive should be something we can accomplish without negatively affecting revenue and it would certainly be positive for growth. In fact, my guess is that, if done right, we might actually see a rise in revenue. But the two sides, who both claim to want to reform the code, can’t even get this done.