How Washington May Ruin Christmas

Retailers could suffer if Congress doesn't provide clarity soon about the "fiscal cliff."

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The U.S. Capitol Christmas Tree is lifted by crew members in Washington. In a few weeks, flashy new congressmen will replace the tree as the most interesting sight on the Hill.

I've been collecting "fiscal cliff" metaphors, and just when it seemed like the bag was getting full, I came across this gem: "You can't help but wonder if Santa's sleigh is headed off a cliff."

[ENJOY: Political Cartoonists Take On the Fiscal Cliff]

That came from retail analyst David Urani of investing firm Wall Street Strategies, who notes that the stock market didn't seem to think the holiday shopping season is off to such a cheery start, even though economists say spending so far is up a healthy 4 percent or so from last year.

On the first full day of trading following the "Gray Thursday" and "Black Friday" frenzies, stocks fell modestly, with many retailers among the biggest losers. Macy's stock fell by a whopping 4.5 percent, Nordstrom by 4 percent, Target by 2.6 percent, and Wal-Mart by about half a point. Other retailers losing ground include Saks, Ann Taylor, Coach and Aeropostale.

So if shoppers are spending, why are investors so bearish on retail stocks? Two familiar words: Fiscal cliff.

[READ: Why Republicans Are Abandoning Their No-Tax Pledge]

Shoppers seem to be blithely unaware of the chaos Washington may be about to unleash on the economy, or else they suddenly have newfound confidence in politicians' ability to make prompt, proficient, business-like decisions. As economists are keenly aware, a slew of tax hikes and spending cuts are due to go into effect Jan. 1 that could cut 4 percentage points off of GDP, causing a fresh recession. Congress might come up with a plan to forestall all that pain, or some of it. But Congress might also do nothing, or gamble on going over the cliff, then trying to undo the damage sometime in 2013, when the next Congress won't face such pressing deadlines.

Investors, needless to say, are hoping for a happy outcome, but preparing for a grim one. If all of the scheduled tax hikes go into effect, it will take $536 billion in spending power out of the economy in 2013 and cost the average family an extra $3,400, according to estimates from the nonpartisan Tax Policy Center. That's so draconian, Congress probably won't let it happen. But if only some of the tax hikes take effect, it could still cut into consumers' disposable income enough to make the difference between a jolly or a gloomy holiday season.

The temporary payroll tax cut first passed in 2009, for instance, puts an extra $115 billion per year into consumers' pockets, and there's a good chance that it won't get renewed. Total holiday shopping this year is expected to hit about $586 billion, according to the National Retail Federation. If the payroll tax cut ends, it will reduce the typical paycheck by about $80 per month, starting next year. For most consumers, that wouldn't be devastating, But alarmed consumers who knew this was coming might cut back on spending right away. And if worries like that cut the typical holiday budget by even five percent, it would wreck the year's biggest shopping season for many retailers, turning profits into losses.

[READ: Why It's a Bad Time to Be Rich]

Shoppers don't seem worried so far. But headlines about the fiscal cliff negotiations will get a lot bigger as the Jan. 1 deadline draws near, especially since Congress usually adjourns for the year a week or so before Christmas. As Urani points out, Congress could give everybody a gift by coming up with a plan—sooner than later—that resolves all the uncertainty about taxes and spending. Ideally, middle-class taxes wouldn't rise for the forseeable future. "If they could confirm this before Christmas," says Urani, "I think we could see a last minute burst of shopping."

But what will happen if Congress adjourns for the year with no decisions at all? At a minimum, it would probably discourage last-minute splurges and possibly force retailers to discount merchandise more heavily than they would like. Shoppers could scrap unnecessary purchases altogether and focus simply on gifts deemed necessary. This could be one holiday season that runs out of steam, if Washington doesn't steer Santa's sleigh in the right direction.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success. Follow him on Twitter: @rickjnewman.