Monday evening, President Obama outlined the elements of a bipartisan compromise on the Bush tax cuts, which were set to expire at the end of the year.  We are instinctively cynical about Washington politics, so we were both shocked by the timing of the coalescence and awed by the lopsidedness of the “compromise” – but in a good way.  Gone are virtually all of the Democrats’ staunchly-held deal breakers like extending the cuts for rich Americans earning over $250,000.  In fact, from an investment perspective, the package is more positive than we dared to dream:

Marginal income tax rates will remain the same (for everyone).  Capital gains tax rates will remain the same (15% for long-term gains).  Dividend tax rates will remain the same (15% for qualified dividends).  The estate tax exemption will increase to$5,000,000 (up from $3,500,000 in 2009).  Social security taxes will be reduced from 6.2% to 4.2% for employees for one year (this is a meager attempt at the payroll tax holiday we wanted).  Additionally, the package provides tax incentives for small business investment.

While the package looks more like a Republican’s Christmas wish list, Democrats aren’t going home empty handed.  Unemployment benefits will be extended an additional 13 months, and the temporary nature of the Bush-era tax cut extension (through 2012) allows opponents to say they don’t like it but that it had to be done given the still-fragile nature of the recovery.  Unfortunately, the president whiffed at another opportunity to appear positive and conciliatory, saying “In fact, there are things in here that I don’t like – namely the extension of the tax cuts for the wealthiest Americans and the wealthiest estates. But these tax cuts will expire in two years.”  Surely no one believes that America is worse off for having clarity on taxes even if it is for just two more years.  Furthermore, the suggestion that one of the best aspects of the compromise is that we’ll have the same uncertainty and political infighting in 24 months is disconcerting. 

Ironically, this compromise, like it or not, removes a monumental impediment to economic growth and provides the “framework” for the recovery to morph into a sustainable economic expansion. And at a time when the Democrats are newly focused on deficit reduction (evidenced by the creation of a deficit reduction commission whose recommendations will be serious and sound very logical but will not be binding) pro-growth fiscal policy will do more to reduce the deficit than the musings of any commission. Almost like winning by accident.