The term has been floating around the Internet and various news sites for months, but so far the so-called fiscal cliff has remained a remote speck in the distance for most Americans as they live their daily lives.
But the fiscal cliff could be a lot closer and more likely to happen than most people believe, and, if it does, get ready for a wallop to your pocketbook. Specifically, if Congress cannot reach a deal by the end of the year, a barrage of automatic tax hikes – including an end to Bush-era and payroll tax cuts – are scheduled to increase taxes for families next year by an average of $3,446, according to a new report by the Tax Policy Center.
For the middle class, the sticker shock wouldn’t be quite as bad, but gruesome enough – the Policy Center report indicates those households would lose 4.4 percent of their income, or approximately $1,984. The poorest families would take a hit of $412 a year, while the now famous top 1 percent of earners would say goodbye to 10.5 percent of their after-tax income, or $120,537.
The lapse of the payroll tax cut alone would cost the average American about $1,000 a year. President Obama and Congress extended the cut in the tax rate from 6.2 percent to 4.2 percent.
Add to all that spending cuts due to sequestration, and, in a time of already stagnating incomes and high unemployment, another recession would be almost inevitable.
“Taken together, the scheduled changes would significantly increase the marginal tax rates that can influence behavior,” the report by the Urban Institute and Brookings Institution stated. “Average marginal tax rates would increase by 5 percentage points on labor income, by 7 points on capital gains, and by more than 20 points on dividends.”
Such higher taxes would no doubt slow investment in new jobs and curb consumer demand. And that likely would push the economy over the edge.
But just how likely is it? After all, potentially devastating cliffs have been avoided before – government shutdowns, debt-ceiling deadlines – so what are the odds of a deal this time?
That’s hard to say, but it’s far from a foregone conclusion any compromise will be reached, especially if the president is re-elected. For his part, Obama and his Democratic colleagues insist that Bush-era tax cuts must expire for “millionaires and billionaires” (couples making $250,000 a year or more), and the president believes the Republicans, if they are rebuffed at the polls, will be forced to the table to bargain.
That could turn out to be wishful thinking. The GOP is heavily favored to retain solid control of the U.S. House of Representatives, and, even if Senate Republicans might be open to compromise, there’s no guarantee the more Tea Party-oriented House, with its loathing of tax increases, would go along.
GOP conservatives argue that raising taxes on those making more than $250,000 a year will hit thousands of small businesses whose owners file taxes as individuals rather than corporate entities. They insist instead on cutting historically high levels of government spending.
The problem is not being ignored. The New York Times reported this week that Senate leaders are mulling a possible solution. Under one scenario, the Times reported, the plan would reduce the deficit by $4 trillion over the next decade. Among other things, the tax code would be reformed, and Medicare, Social Security and other programs would be cut by some as-yet-undecided degree.
Barring that, The Times article stated, the plan first offered by the leaders of Obama’s fiscal commission, Erskine B. Bowles and former Sen. Alan K. Simpson, would be effectively revived. That blueprint would also pare Social Security and other programs, as well as lower tax rates, but it would eliminate deductions and tax credits as well.
But, again, if Obama wins, reaching any such agreement would be challenging, and not just because of House Republicans. Liberal Democrats would oppose it, too, and Times columnist Paul Krugman wasted no time in doing so after the article appeared.
“Just to say, this would be politically stupid as well as a betrayal of the electorate,” Krugman wrote.
Should Romney win, he might be more likely to gain House support for the Senate plan – he has likened his own deficit reduction ideas to Simpson-Bowles – but that would be no cake walk, either. For one thing, his running mate, Rep. Paul Ryan, voted against the Simpson-Bowles plan when it came before Congress, in part because of its health-care provisions, in part because of too many tax increases.
“Their proposal is a serious and credible plan, but I cannot support it,” Ryan said at the time. “We must address the explosive growth of our health care entitlement programs at the structural level to meet the fiscal and economic challenges confronting this nation. This plan not only lacks needed structural reforms, but would in fact take us in the wrong direction on health care by accelerating the adverse consequences of the President’s health care law. It also relies too heavily on tax increases, which would stifle the very growth and prosperity that are the essential preconditions of a sustainable fiscal path.”
With a Romney win, the health-care obstacles to a compromise might be overcome – particularly if the Affordable Care Act is derailed – but any tax increases embedded in the proposal would remain highly problematic.
Meanwhile, the two presidential candidates are blaming the other side. Last week, the White House released a list of the proposed cuts and criticized congressional Republicans for refusing to give any ground in negotiations. Romney took to his weekly podcast to blame the president.
“Political gridlock threatens to plunge us back into recession, but instead of seeking bipartisan solutions, President Obama is passively allowing us to go over a fiscal cliff,” Romney said.
Broad economic implications
Aside from the grim impact going over the fiscal cliff would have on American families, what are the broader economic implications? The Congressional Budget Office took a recent look, not only at the impact of tax increases but at the effects of sequestration, or automatic spending cuts required by the Budget Control Act of 2011.
What it found at the bottom of the fiscal cliff was a recession.
“Under current law, the federal budget deficit will fall dramatically between 2012 and 2013 owing to scheduled increases in taxes and, to a lesser extent, scheduled reductions in spending – a development that some observers have referred to as a ‘fiscal cliff,’” the CBO report stated.
While the tax hikes would boost revenues significantly next year, the report stated, the automatic enforcement procedures established in the Budget Control Act of 2011 would lower spending.
“Taken together, CBO estimates, those policies will reduce the federal budget deficit by $607 billion, or 4.0 percent of gross domestic product (GDP), between fiscal years 2012 and 2013,” the report stated.
But, the CBO continued, the resulting weakening of the economy would lower taxable incomes and raise unemployment, thereby reducing tax revenues and increasing spending on such things as unemployment insurance.
“With that economic feedback incorporated, the deficit will drop by $560 billion between fiscal years 2012 and 2013, CBO projects,” the report stated. “... According to CBO’s estimates, the tax and spending policies that will be in effect under current law will reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013 (with the resulting economic feedback included, the reduction will be smaller).”
Under those fiscal conditions, the report continued, growth in real inflation-adjusted GDP in calendar year 2013 would be just 0.5 percent, with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and to expand at an annual rate of 2.3 percent in the second half.
“Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession,” the report concluded.
And what would happen if lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1 percent? the CBO asked.
“In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, well above the 0.5 percent projected for 2013 under current law,” the budget office concluded.
Richard Moore may be reached at email@example.com