Even though the White House and Congress have come to an agreement to avoid the fiscal cliff, a number of challenges must be solved to get the U.S. economy back on track, according to financial planners.
President Barack Obama and the Republican-controlled House of Representatives were able to agree to an 11th-hour deal that increased taxes for American families making more than $450,000 per year. These families will also have to pay higher capital gains taxes. The rest of the country will experience no increase in income tax, although Social Security taxes will rise from 4.2 percent to 6.2 percent.
The tax agreement prevents hundreds of billions of dollars from being removed from taxpayers' pocketbooks. But it failed to address other pressing issues, like the national debt and lavish government spending, both of which pose long-term threats to the health of the U.S. economy.
"The fact that we didn't completely go over the cliff is a good thing, but there are major issues that haven't been addressed," says Lisa Kirchenbauer, president of Omega Wealth Management in Arlington, Va. "This is going to lead to some volatility for consumers and investors over the next [few] months."
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Spending cuts delayed, but decreases are coming. Under the terms of the agreement, sequestration--automatic spending cuts set to take place across the federal government--will be delayed for two months. These cuts are part of a broad reduction in federal spending meant to lower the national debt.
According to Kirchenbauer, these cuts, while delayed, are still likely to occur down the line--especially cuts to the Department of Defense's budget. These cuts would impact consumers from any region where the Pentagon has a significant presence, she says.
She adds that the Washington, D.C., area would also likely suffer due to budget cuts across the federal government. "If you rely on the government for business, there is still uncertainty. In the national capital area, it's a huge issue. It could impact your job or your business," Kirchenbauer says.
Debt-ceiling fight looms. The fiscal-cliff deal also failed to address the debt ceiling, an issue that has inflicted considerable pain on the U.S. economy. In the summer of 2011, Republicans and Democrats agreed on a last-second deal to increase the limit on how much the country could borrow, allowing the United States to pay its debt. Markets, however, were not impressed with the deal, and Standard & Poor's downgraded U.S. debt for the first time in the country's history.
By February or March, the United States will hit the debt ceiling again. If this occurs, or negotiations on the ceiling draw out until the last minute, Kirchenbauer predicts markets will react similarly to the 2011 fight.
"The ratings agencies are not happy with the results [of the fiscal-cliff deal]," she says. "It's still possible that we could get downgraded. This is going to create continued uncertainty in financial markets."
Positives emerge from the deal. According to Adam Sherman, chief executive officer of Firstrust Financial Resources in Philadelphia, not all the news resulting from the fiscal-cliff deal is bad. For instance, he says politicians in Washington have shown they are capable of coming together to form a deal. The Dow Jones Industrial Average responded by jumping nearly 300 points in the first trading session after the deal was announced.
"When push comes to shove, Washington showed it can act as a democracy and get things done," Sherman says. Prior to the deal, "there was little faith [Democrats and Republicans] could work together."
He adds that the tax increases on the rich were not as high as many had feared, making the deal more palatable to wealthy Americans. "If [the wealthy] saw something that was really extreme, say an increase to 45-percent income tax, the normal nature of those individuals is to digest and to slow down," he says. "Now that we have some clarity, most logical thinkers are thinking the tax increases are within acceptable levels of taxation and will allow wealthy business owners to continue to grow their business."
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Both Sherman and Kirchenbauer say they believe Washington has finally provided guidance on what national policy will be over the next four years. While it's not yet clear how the Affordable Care Act or the Dodd-Frank Wall Street Reform and Consumer Protection Act will change regulations, the tax code is now clearly defined, removing an enormous amount of uncertainty from the market.
"The best way to fix these problems is to grow our way out of it. The government is creating the roadmap for us to potentially follow," says Sherman. "It will be interesting to see if they can adjust the course of spending and entitlements, but the roadmap is now out there. The government had laid the blueprint to let the private sector drive [economic growth.]"
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