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What Happens if We Fall Off the Fiscal Cliff?

The time has come for Americans to begin to manage their expectations about the outcome of the fiscal cliff negotiations. There is not enough time for any resolution that even approaches a grand bargain. But, there is time to do a simple transaction, which includes promises to take further action in 2013. Today is December 28, the fiscal cliff will occur on January 1; and Congress has returned to begin deliberates today.

The fiscal cliff will increase taxes on all Americans by $536 billion; $110 billion of spending cuts will be implemented and split between defense (a cut of 9%), and other social programs (a cut of 8%).

It is possible that the fiscal cliff might be extended to give the president and Congress more time to make a deal. But, this could result in a very adverse reaction in the stock market. Americans do not need another hit to their investments on the heels of a catastrophic drop in housing prices. Consumers and businesses would likely decrease spending because of the continuing uncertainty, so job gains and economic improvements would not be forthcoming. Ben Bernanke, the Federal Reserve Chairman, has warned that continuing uncertainty will have a meaningful negative impact on the economy.

Let’s assume that there is no new deal in 2013. How would this turn of events impact Americans? Taxes would increase by $2,400 on families earning between $50,000 and 75,000 according the Tax Policy Center. Consumers will receive less in their paychecks, so that businesses and jobs will suffer. Cuts in government services will precipitate federal furloughs and layoffs. Companies will lose government business. And 3 to 4 million jobs would be lost according to the Congressional Budget Office.

But, this is not all. Several tax breaks from 2009, implemented to stimulate the economy, will expire on January 1.

The alternative minimum tax adopted in 1960 to ensure rich people do not avoid paying any taxes by accumulating deductions and credits, will soon hurt 30 million additional households earning as little as $45,000. These households would experience higher taxes of $3,700 for 2012. A failure to extend AMT exclusions would delay tax filings until late March, and refunds for as many as 100 million households will also be delayed as the Internal Revenue Service overhauls its computers. The IRS usually pays about $200 billion  in refunds during the period of January to March. These refunds are applied to bills and assist the economy as consumers spend money during the post- holiday lull.

The capital gains tax rate could be increased from 15% to 23.8%. This tax increase applies almost exclusively to wealthy investors. Annual capital gains benefits are $77 billion (the difference between a 15% rate and investors’ income tax rate). This amount would decrease significantly if capital gains rates were increased by the aforementioned 60% increment.

Estate taxes will increase from 35% to 55%. Once again, this increase would primarily affect wealthy Americans.

In 2013, the maximum Social Security tax withholding will rise from $4,624.20 (4.2% on income up to $110,1000) to $7,049.40 (6.2% on income up to $113,700). This increase will impact the paychecks of all Americans. Those earning $50,000 will have their payroll taxes increase by $1,000.

Two million Americans are scheduled to lose federal unemployment aid. The president has proposed to extend this program along with more money for public works and for homeowners at a total cost of $200 billion.

Social Security recipients may receive less income prospectively, as both political parties are in favor of decreasing future cost of living adjustments. This reflects lower inflationary pressures in our economy.

The current deal proposed by the president calls for $1.6 billion of new taxes on those earning more than $250,000, $600 billion of spending cuts (including $350 billion from Medicare), less an outlay of $200 billion for unemployment and other items, and an extension of the debt ceiling issue.

Republicans are currently against any tax increases. This is a bizarre stance considering that 67% of the top earners are in favor of higher income taxes. Although, 64% believe they are carrying an unfair tax burden. Republicans want significantly more spending cuts and are focusing on Social Security, Medicare, and Medicaid. Presumably, they will go along with increased aid for the unemployed, although this is not a sure bet. And, Republicans will not agree to a long-term extension of the debt ceiling issue, which as of today is a major negotiating point.

Timothy Geithner, Secretary of the Treasury, has given notice to Congress that he would “take ‘extraordinary measures’ to keep the government afloat.” He said he did not know how long he could do this before the government must borrow more money above the current debt ceiling.

It certainly seems like time is running out on the fiscal cliff issue. Damage will occur even if the fiscal cliff is avoided, as many will pay more taxes and/or lose services.

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