Fiscal cliff

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The "fiscal cliff" refers to a combination of tax increases and spending cuts that were set to take place simultaneously in the U.S. at the end of 2012, just as the country approached the debt ceiling.[1][2] The draconian provisions were originally designed to force a compromise between Democrats and Republicans in the U.S. Senate and the House of Representatives on reducing the debt. The biggest sticking point was whether to extend the expiring George W. Bush-era tax cuts for the wealthiest 2 percent of U.S. households through 2013.

After the November general election, Republican and Democratic leaders in both the House and Senate expressed optimism that they and the White House could agree on measures to raise federal revenue and cut spending before the Jan. 1 deadline.[3]

On Jan. 1, 2013, a deal was reached on tax cuts for lower income households and higher rates for individuals earning over $400,000 and families earning over $450,000 annually. The deal also raised rates on those making more than that from 35% to 39.6%, bringing back a top tax bracket from the Clinton administration. It increased the tax on investment income from 15 percent to 23.8 percent for filers in the top income bracket and added a 3.8 percent surtax on investment income for individuals earning more than $200,000 and couples making more than $250,000. The deal also gave U.S. taxpayers greater certainty regarding the alternative minimum tax and left several popular tax breaks in place, such as the exemption for interest on municipal bonds.[4]

According to various estimates, it will raise roughly $600 billion in new revenues over 10 years.

The bill also extended unemployment insurance and delayed for two months the threat of sequestration -- a series of automatic, across-the-board cuts in federal spending.[5] The government technically went "over the cliff," since the deal was not completed until after the beginning of the New Year, but the changes incorporated in the deal were backdated to January 1.[6]

The U.S. was expected to reach its debt ceiling by mid-January 2013.[7] The deal that averted the fiscal cliff is known as the American Taxpayer Relief Act of 2012. It was passed by the U.S. Congress on Jan. 1, 2013, and signed into law by President Barack Obama on January 2, 2013.

Tax Increases

A package of tax cuts enacted in 2001 and 2003, consisting of payroll, capital gains and dividend tax cuts, were set to expire if no action was taken by the end of 2012. Approximately $532 billion in tax increases were set to take place, including $295 billion in income tax, an $127 billion increase from ending the payroll tax holiday, and $87 billion in other tax provisions.

Additionally, several provisions of the U.S.'s Affordable Care Act are set to begin, which will raise taxes by $24 billion. Finally, several tax credits, such as a research and experimentation credit, were scheduled to sunset in January 2013. Certain tax breaks for businesses would be cut, and there was the possibility that the alternative minimum tax would hit about a quarter of U.S. taxpayers.[8] [9]

Some of the tax measures would hit paychecks and corporate bottom lines immediately, but others would be more gradual, leading some people to refer to it as a fiscal "slope". The "sequester" spending cuts, for example, would not be required until May 2013, and other measures could be delayed by the administration.

In October of 2012, the Tax Policy Center — a joint project of the Urban Institute and the Brookings Institution - put together a study that summarized how falling over the fiscal cliff would play out for individuals in various tax brackets.[10] The study said the average tax hike in dollars that an individual in the middle class would see - those with about $64,484 in income - would be $1,984.[11]

Spending Cuts

The Budget Control Act of 2011, enacted as part of the debt ceiling debate in 2011 and set to begin Jan. 2 2013, consists of automatic spending cuts or "sequestration" of funds amounting to a total of $136 billion, or 0.8 percent of GDP. About $87 billion will be cut from domestic and defense discretionary spending; $35 billion in expiring extended unemployment benefits, and $15 billion in reduced Medicare doctor rates.[12]

Half of the scheduled annual cuts ($109 billion/year from 2013-2021) will come directly from the national defense budget, half from non-defense. However, some 70 percent of mandatory spending will be exempt. [13]

Debt Ceiling

The U.S. Treasury estimates that the country will reach its debt ceiling, currently $16.394 trillion, in early 2013. The last debt ceiling debate, in the summer of 2011, resulted in a political standoff that rattled financial markets.

Potential Effects

The Congressional Budget Office (CBO) has estimated that going off the cliff would reduce U.S. growth by about 4 percentage points from what it would have been otherwise. This is expected to lead to a recession in the first half of 2013. Recent research from the IMF and others suggests that the compounded effect of the measures on the overall economy could be even larger than the CBO's assumption because of weakness in the global environment and the limited ability of the Fed to ease policy to offset the fiscal tightening.[14]

History

In 2001, President George W. Bush and Republicans in Congress couldn't get the 60 votes in the Senate required to pass his initial 10-year, $1.7 trillion tax cut, so they used a legislative process known as reconciliation to pass the tax cuts with a Senate majority of 51 votes. Using this method, however, meant the tax cuts would expire after the 10-year budget window closed in 2011. When Bush pressed for another round of tax cuts in 2003, Republicans in Congress used reconciliation again to avoid a Democratic filibuster and maximized the initial size of the tax cuts by having them expire at the same time as the first tax cuts, in 2011.

After the 2010 elections, President Obama struck a deal with Republicans to extend the tax cuts for another two years and included other tax measures such as the payroll tax cut. If the fiscal cliff is not averted, those measures will end on Jan. 1, 2013.

In 2011, the newly elected Republican House refused to raise the debt ceiling without a guarantee that the increase would be at least matched by deficit reduction. Congress and the White House agreed to spending caps that shaved about $1 trillion off projected growth over 10 years. They also created a bipartisan deficit reduction committee, known as the supercommittee, to find another $1.2 trillion in savings over 10 years. If that effort failed, automatic cuts in defense and non-defense programs would start in 2013. [15]

In 2011, a potential “grand bargain” between Barack Obama and John Boehner collapsed in anger and finger-pointing.[16]

Fiscal Cliff Talks

As of mid-December 2012, proposals to solve the fiscal cliff problem were coming from both sides of the aisle. As part of its budget proposal, the White House lowered its target for new tax revenue to $1.4 trillion, down from President Barack Obama's initial offer of $1.6 trillion. It retained items from an earlier offer that had irked Republicans, included new stimulus spending and an increase in the U.S.'s borrowing limit. The White House told Republicans it would include an overhaul of the corporate-tax code as part of any deal to reduce the deficit. Republican proposals called for lowering the corporate rate to 25 percent.[17]

Resources

References

  1. Goldman to Clients: Get Out of Stocks Before Fiscal Cliff Hits. CNBC.
  2. Everything you need to know about the fiscal cliff in one post. Washington Post.
  3. Obama, congressional leaders begin ‘fiscal cliff’ talks. Washington Post.
  4. What is the Fiscal Cliff?. About.com.
  5. Obama signs bill warding off fiscal cliff. CNN.
  6. What is the Fiscal Cliff?. About.com.
  7. Fiscal cliff compromise leaves few satisfied. Reuters.
  8. What is the Fiscal Cliff?. About.com.
  9. Times Topics: Alternative Minimum Tax. The New York Times.
  10. Toppling Off the Fiscal Cliff: Whose Taxes Rise and How Much?. Tax Policy Center.
  11. What a fiscal-cliff plunge would cost you. MarketWatch.
  12. What Is the Fiscal Cliff?. WSJ News Graphics.
  13. What Is the Fiscal Cliff?. U.S. Council on Foreign Relations.
  14. Confronting the Fiscal Cliff. Council on Foreign Relations.
  15. Q&A: Understanding the fiscal cliff. The New York Times.
  16. Both sides appear upbeat on opening round of ‘fiscal cliff’ talks. The Washington Post.
  17. Corporate Taxes on Table in Cliff Talks. The Wall Street Journal.