The “Fiscal Cliff”-How will it affect you?

The “Fiscal Cliff”-How will it affect you?

The Facts:

As the end of 2012 approaches, business owners, investors, and the public at large will increasingly discuss the possibilities for the coming “fiscal cliff,” a combination of tax increases and spending cuts that will be automatically triggered at year-end unless Congress decides to act. Should our nation’s leaders decide not to act on these matters before the end of the year, here are some of the potential consequences the citizens of the U.S. may face:

1. Ending of the Bush Tax Cuts: In general, this will result in increased tax rates for most. The current tax structure of 10%/15%/25%/28%/33%/35% will change to 15%/28%/31%/36%/39.6% in 2013.

2. Long-term capital gains tax will rise from 15% to 20% and dividends will likely be taxed as ordinary income.

3. The temporary 2% reduction in employee-paid Social Security tax will expire.


4. The estate tax structure will change significantly, with the exclusion for estate and gift tax to drop from $5.12 million in 2012 to $1 million in 2013. Additionally, the top estate tax rate increases to 55% from 35%.

5. High earners (those single filers earning over $200,000, married filers over $250,000, or individuals married filing jointly over $125,000) will be the most affected. For these taxpayers, certain itemized and dependency deductions will be reduced or removed, and the Medicare tax on these individuals will be raised an additional 0.9%. On unearned income, these individuals will pay an additional 3.8% in Medicare tax.


6. Education, transportation, and energy programs will be the hardest hit by mandatory spending cuts set to take place over the next several years.

While none of these consequences are foregone conclusions at this point, our nation inches closer and closer to the coming “fiscal cliff” as the elections have ended and the new year deadline approaches. Unfortunately, much of the debate for finding resolution on these topics will likely be delayed by an arrogant Congress.

The fiscal cliff is a powerful metaphor. It sounds like an impending disaster, but in reality, we’ll wake up on the morning of Jan. 3 and life will be unchanged. Sure, tax rates will nominally be higher, some tax breaks will have been canceled, and the government will be expected to implement major cuts in military and domestic spending. If that continues for several months, it will have an adverse effect on the economy.

But letting the law take effect will also have some real benefits. For one thing, on the other side of the cliff, we’ll be a big step closer to the kind of fundamental reform of the tax code that both Democrats and Republicans say they want. Two provisions that limit the deductions and personal exemptions the wealthy can take — similar to the cap on deductions proposed by Mitt Romney — will come back into effect. Capital-gains rates will rise from 15% to 20%, and dividends will be taxed at normal rates, reducing the incentives for tricks like the notorious carried-interest loophole. And instead of a tax system that produces less revenue as a percentage of GDP than at any time since 1950, we’ll move toward one that is adequate to the needs of a modern, dynamic economy. The fiscal cliff is, all by itself, a budget deal and a step toward tax reform; A flawed and dangerous one, to be sure, but a far superior starting point for a real budget agreement than the temporary rules of 2012.

Once tax rates and other provisions have returned to their previous levels, as planned, Congress and the White House will have a little time to look at taxes and spending and decide how best to keep the economy moving now and in the future. Is it by cutting taxes for low- and middle-income working families, who were hit hardest by the recession and gained little in the George W. Bush years, when most of the benefits of growth went to the top? Or is it another round of tax cuts for those who have gained the most?

Let’s remember also that the fiscal cliff is not a natural phenomenon; it’s the law. None of the tax cuts that will be changed by it were supposed to be permanent in the first place. Some of the cuts — mostly those from the early Obama years — were to provide economic stimulus during the recession. Those should be revisited every couple of years, and if we think the economy still needs a boost, we should renew them for another year or two. But, the bulk of the tax cuts that expire date from 2001 and ’03. At that time, when our country had budget surpluses, both Democrats and Republicans wanted to cut taxes. But Republicans wanted to cut them by about twice as much and to make much bigger cuts for the wealthy than for the middle class. Rather than compromise with Democrats, Republicans twice employed a special rule, known as reconciliation, to use their narrow congressional majorities to push their version of tax cuts through. Because that special rule can’t be used to make permanent changes that worsen the deficit, they had to put an expiration date on those tax cuts. So the fiscal cliff is a long-overdue chance to revisit choices from the past and better address what we need to do for our future.

In the world on the other side of the fiscal cliff, Democrats and Republicans will have no choice but to work together on tax cuts that will be fairer to the middle class and encourage economic growth. And then, over several years, we have an obligation to look closely at Medicare in particular and figure out how to slow the growth of health care costs in that program. That work can only begin on the other side of the fiscal cliff.

Personal Opinion:

To barge through this political gridlock and get the parties into position for real compromise, I hereby suggest they go over the cliff.

The implications would not be felt for several months, giving time for making amends. Both sides would have "held out to the end," satisfying their most ardent flag-wavers. The threats of tax hikes and spending cuts would be real, putting politicians on the spot without time to dally.

And the challenge would become one of adding benefits and mitigating tax pain, a much easier proposition than reducing benefits and adding pain before the deadline.

Republicans would agree to reinstate tax cuts for everyone except individuals making more than $200,000 a year and families making more than $250,000.

Democrats would agree to more entitlement program reform than they would before the cliff deadline.

Today's admonitions are based on worst-case implications if the tax hikes and spending cuts go fully into permanent effect, which is not in the cards, regardless. Let both sides jump in the soup together by letting the cliff deadline pass. Then we'll see the fur fly, and at the end of a few weeks all hands will wring out the kind of compromise solution they can't reach until dawdling is not an option. The changed political dynamic will bring it on. The fiscal cliff will have done its tactical duty.

So, you Thelma and Louise’s out there; What do you think?