The tax provisions set to take effect in 2013 would combine to raise taxes for nearly all Americans.
• Per-child tax credit drops from $1,000 to $500.
• The long-term capital gains rate climbs from 15 percent to 20 percent on most investments, from 0 to 10 percent for lower-income taxpayers.
• Dividends taxed as regular income instead of current 15 percent rate. Top rate climbs back to 39.6 percent.
• Estate tax exemption falls from $5 million back to $1 million, and rate climbs from 35 percent back to 55 percent.
• Patch that has kept many upper-middle-income families from becoming subject to the Alternative Minimum Tax expires. Some 34 million more families subject to the tax.
• Series of short-term tax breaks routinely extended by Congress expire, including provision for deductibility of state and local taxes, an adoption credit and several business incentives.
• Additional child credits and earned income tax credits created for low-income taxpayers as part of the 2009 stimulus expire.
• Maximum tax credit for families paying college tuition drops from $2,500 to $1,800, and eligibility drops from four to two years.
• Under the Affordable Care Act, earnings by individuals above $200,000 and by families above $250,000 will be subject to a new 0.9 percent tax. In addition, dividends or capital gains above those thresholds subject to additional 3.8 percent tax.
Just as the nation is finally climbing out of the malaise of the Great Recession, the economy stands poised on the verge of an economic free fall — one that is completely of Washington's making.
It's the much-talked-about "fiscal cliff.''
That's shorthand for a list of federal tax increases and budget cuts set to take effect at the first of the year because of previous actions by Congress and President Barack Obama.
And one important thing to know is this: The taxes would hit nearly every American — anyone who draws a paycheck, pays federal income taxes or profits from investments.
Gone would be the Bush-era tax cuts and the more recent payroll tax cut. Also gone would be tax credits that benefit families with children, help pay for college and make low-wage jobs more livable for the working poor.
Inheritance taxes would shoot back up, and millions of upper-middle-income families would fall under the Alternative Minimum Tax.
One study found that, combined, the tax increases would boost the average household's federal tax bill by nearly 5 percent — some $3,500 a year.
Jeff Minchew, a Glenwood, Iowa, resident who works for an industrial scale company in Omaha, is staring at the possibility of losing $500 in income tax credits for each of his three kids and would pay higher income tax rates, and he and his wife would see each of their paychecks decrease by 2 percent with the end of the payroll tax cut.
He figures the cliff would leave his family with roughly $3,000 less to spend, at a time when prices seem to be going up on everything.
"People better be concerned about it,'' Minchew said. "It's not good news for the average working-class family.''
Also part of the fiscal cliff is a package of steep, automatic federal spending cuts that would pull still billions more out of the economy.
Nearly all economists say the combined jolt of tax increases and spending cuts would be sure to send the nation back into a job-killing recession in 2013. In fact, most say just the prospect of it has already been affecting job growth for months.
"I'm not an alarmist, but this one does alarm me,'' said John Bartle, acting dean of the University of Nebraska at Omaha College of Public Affairs and Community Service.
"It's such a dramatic shock to the system, I think the economy would be in real danger of a significant second recession.''
The president and Congress have the ability to slam on the brakes before the nation drives off the cliff, calling off or postponing the tax hikes and spending cuts.
It would seem the prospect of a recession would be enough to get the parties to agree, either in a lame-duck session of Congress or by sometime early next year. The nation also is again running up against its debt ceiling by the end of the year, providing more pressure to act.
However, with both the president and a staunchly conservative Republican House of Representatives voted back into office Tuesday, it's not at all clear that the gridlock of recent years is going away.
The conciliatory tone in Washington in the aftermath of the election last week offers no guarantee that, come Jan. 1, we won't be taking a reckless "Thelma and Louise''-style flier right off that cliff.
"There are just too many people who would be affected by driving over the cliff to be in my view politically acceptable,'' said John Cederberg, a business tax consultant in Lincoln. "But who knows? The partisanship in this country is out of control.''
Nearly every taxpayer would see a significant federal tax bite if payroll, income and other federal tax rates increase as currently scheduled on Jan. 1. Even just the payroll tax increase, seen by many as likely to occur, would take a noticeable bite.
|Average annual federal tax increase||Percent change after-tax income||Annual payroll tax increase only|
Even if policymakers are able to postpone the most onerous provisions and avoid a recession, it might be a good idea for wage earners to plan on their paychecks being 2 percent smaller after Jan. 1. Up to this point, neither Obama nor many others have talked about trying to extend the payroll tax cut that has effectively boosted take-home pay over the past two years. That might be something to consider when budgeting for the holidays and year ahead.
"The payroll tax cut is probably going under any circumstances,'' said Rudolph Penner, a federal budget expert with the Urban Institute in Washington. "That's not insignificant.''
So, how did we get here?
In short, the fiscal cliff is a product of Congress and the two most recent presidents continuing to kick the can down the road when it comes to facing up to the nation's fiscal problems.
The federal government was actually running budget surpluses when President George W. Bush first pushed big tax cuts through Congress in 2001 and 2003. Lawmakers reduced income taxes across the board and made big reductions in dividend and capital gains taxes and inheritance taxes.
But with budget hawks fearing future deficits, Congress was reluctant to make the changes permanent, scheduling them to sunset after 2010. Indeed, combined with hundreds of billions of nonbudgeted dollars spent on two wars, the tax cuts helped send the federal budget under Bush significantly into the red.
Then the housing bubble burst and the nation plunged into the greatest financial crisis since the Great Depression. Annual deficits then reached more than $1 trillion annually through a combination of falling federal tax revenue and steps in Washington to avert a deeper crisis. The payroll tax cut was one such action, intended to boost worker pay and stimulate consumer spending.
With the economy still struggling in 2010, Obama and Congress agreed it wasn't the time to increase taxes, so they moved to extend the Bush tax cuts through the end of 2012.
Then, while wrangling over raising the federal debt ceiling in August 2011, Obama and Republicans in Congress created a supercommittee to look for $1.2 trillion in budget savings over the coming decade. If the committee could not reach agreement, a series of deep across-the-board cuts in military and domestic spending would automatically take effect on Jan. 1 — the same day the Bush tax cuts and numerous other tax provisions were set to expire.
The idea was that the combination of deep budget cuts and big tax increases would be so onerous and unacceptable to Democrats as well as Republicans that it would prompt the supercommittee to hash out a long-term agreement.
But amid the election-year paralysis in Washington, that plan proved to be a colossal failure. Now that recession in a bottle is set to be uncorked.
How much could it affect you?
On the tax side alone, a recent study by the Tax Policy Center in Washington showed it would directly affect about 90 percent of all Americans.
Even the most modest of income earners would be hit by ending the payroll tax cut and eliminating an enhanced earned income tax credit that was part of the Obama stimulus. For families making less than $20,000 a year, the average tax increase would amount to $400 annually.
Middle-income families would be hit to the tune of $2,000 a year on average. The hardest hit of middle-income taxpayers would be the millions at somewhat higher income levels who would suddenly become subject to the Alternative Minimum Tax, a tax originally created decades ago to keep the rich from using exemptions and loopholes to escape any taxes.
Those new AMT payers would see taxes rise by $3,700 on average.
Wealthy taxpayers would see the biggest tax increases, particularly because they've benefited the most from the big capital gains and dividend tax cuts that were in the Bush package. The average tax increase would be more than $14,000 for those making $108,000 or more. The wealthiest taxpayers, those making $2.6 million or more, would face an average increase of $634,000.
If the Bush cuts expire, the top tax rate on capital gains would go from 15 percent to 20 percent and the top dividends rate would skyrocket from 15 percent to 39.6 percent.
In addition, the Obama health care law imposes a new 3.8 percent tax on capital gains and dividends that exceed $250,000. Those taxes also become effective Jan. 1.
With all the potential new investment taxes, some financial advisers are advising their wealthy clients, particularly those who have made big capital gains while growing successful business enterprises, to sell assets and lock in their gains yet this year.
The impact of the impending budget cuts is harder to quantify, and many might on their face see them as a good thing.
But federal spending is a big part of the economy, with the dollars spent on government purchases and for salaries cycling through the economy just like those in the private sector. Sudden, deep federal cuts would represent another blow.
Combined, the tax increases and spending cuts would represent a $600 billion-plus hit to the economy in 2013, enough to almost surely send the country back into recession.
In August, the nonpartisan Congressional Budget Office warned that if the nation goes over the cliff, the Gross Domestic Product, or the measure of the nation's productivity, would go from current projections of modest growth during the first half of 2013 into a 2.9 percent decline instead.
Some 2 million jobs would be lost, the CBO estimated, the national unemployment rate rising from the current 7.9 percent to 9.1 percent.
Nonetheless, there are some who actually advocate driving off the cliff. The trillion-dollar deficits would automatically be cut in half, down to far more manageable levels.
Projected debt: with or without cuts
Clearly, the nation at some point must get its fiscal house in order. But most economists and budget experts say with the economy still in its fragile state, now is not the time to act on the deficit in any big way. "We're not on life support anymore,'' said Ken Kriz, a UNO economist. "But we're still in critical care.''
At this point, he and others said, the best course of action is to avoid the cliff and its resultant miseries, keep taxes low, allow the economy to grow stronger, and immediately begin work on a plan that would gradually but surely address the budget issues. Any plan would need to address not only current deficits but also the even bigger long-term fiscal challenges posed as retiring baby boomers swell the ranks of the popular but costly Social Security and Medicare programs.
"We do have to transition out of the situation,'' said John Anderson, an economist at the University of Nebraska-Lincoln. "But there needs to be some careful thought and consideration on the right path.''
The Urban Institute's Penner, who last month spoke at UNO on the fiscal cliff, agreed. In fact, he believes driving off the cliff would be even more damaging than what the CBO has forecast, because it would represent yet another major sign that the U.S. political system is completely broken.
And that, he said, would cast huge new doubt on the nation's ability to deal with its longer-term fiscal problems.
"Businesses would be so disillusioned,'' said Penner, a former CBO director. "It would do extraordinary economic damage.''
Penner is not now predicting a Greek-style debt crisis for the United States. But at the same time, history has shown it's impossible to predict just what combination of debt and lack of confidence it takes to send interest rates shooting up 300 basis points, bringing financial markets to their knees.
It's disappointing that neither Obama nor Republicans have been leveling with the American public on the sacrifices it's going to take to restore fiscal order, Penner said.
The good news is that a bipartisan framework for resolving the nation's fiscal problems already exists.
The Simpson-Bowles plan, the product of a 2010 special commission on deficits appointed by Obama, tried to strike a grand bargain by packaging lots of things for members of both parties to both love and hate: budget austerity that includes long-term cuts to domestic programs as well as to defense; tax increases but also tax reforms; and changes to entitlements, including raising the Social Security retirement age for younger workers.
The recommendations were largely ignored during the election year but may gain traction now.
"I personally think something like that is the way we're going to go,'' Penner said. But the key, he said, is to "do it deliberately and sanely.''
Minchew, the Iowa taxpayer, said he is hopeful Obama and Congress can figure out a way to both back away from the cliff and solve the long-term challenges.
"We need to come together and get something done,'' he said. "There are obviously going to have to be compromises on both sides of the aisle.''
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