BOSTON PUBLIC RADIO
12:00 pm
Mon November 12, 2012

The Fiscal Cliff, Explained

Money and American Flag
Credit Images of Money / Flickr Creative Commons

Federal Reserve Chairman Ben Bernanke was the first person to refer to the 1.2 trillion dollars in looming budgetary cuts, as the "fiscal cliff," a name with which some industry insiders take issue. "What a terrible moniker," said financial expert Sheryl Marshall. "I keep thinking of Thelma and Louise."

Marshall believes the fiscal cliff arose because politicians favored short term compromise over long term implications. “This was the drama of unintended consequences. I doubt very much that when the President and Congress made these agreements earlier in the year, to avoid the debt ceiling, that they knew this was going to come down to the fiscal cliff — or, as I like to call it, a steep incline,” Marshall explains.

Marshall cautions us not to panic — she says that even if Congress and the President do not come to an agreement before the fiscal cliff, “It’s not like January 1, the sky is going to fall.” Instead, the effects of the cliff will gradually become, as Marshall puts it, “Something that everybody will feel in their pocketbooks.

Congress came to an agreement that they would reduce the deficit by 1.2 trillion in spending cuts over the next ten years. The planned reduction will come from a combination of spending cuts and tax increases that are scheduled to take effect on January 1, 2013.  However, many experts argue that allowing all of the impending tax hikes and spending cuts to occur simultaneously would trigger a new recession.

Don’t worry — it’s unlikely that all the proposed changes will end up taking effect at the start of 2013. In fact, Salon projects that relatively little will change. But just in case, here’s a look at what would be at stake.

Breaking Down the Cliff

So what would happen if all the laws took effect unchanged? The first element of the fiscal cliff is the Budget Control Act of 2011, a mandatory decrease in government spending by roughly 110 billion dollars that is scheduled to kick in on January 1, 2013.  If this law remains unchanged, there are likely to be automatic cuts in spending wherever federal money is found — from veteran services to farm subsidies and national parks.  

Next, the Bush era tax cuts are also set to expire at the end of the year. The cuts were initially due to expire in 2010, but were extended. The end of the Bush era tax cuts, Marshall explains, would raise capital gains tax from 15 to 25 percent beginning in April of 2014. This is an increase that would primarily affect wealthy individuals — and it’s an increase that would still place capital gains tax at a lower rate than during the Clinton era, when it was 28 percent.

Additionally, Marshall explains that high income Americans are projected to pay an additional tax of .9 percent in their earnings above 250,000 dollars if they are married, and above 200,000 if they are single. They will also pay an additional 3.8% on capital gains, dividend and interest income over those same thresholds. These increases are intended to pay for the Affordable Care Act, and would result in the top earning Americans paying an additional 1,141 dollars in taxes.

The estate tax is also projected to change at the end of the year. Currently, Marshall explains, the first 5 million dollars of a deceased person’s estate is not taxed, and estates are taxed at 35 percent above that marker. At the end of 2012, if a compromise is not reached, the tax exempt amount of an individual’s estate will fall to 1 million dollars, and the tax rate above that exemption will rise to 55 percent.

Which of the impending changes does Marshall think most likely to occur? “I would suspect that the first thing they’re going to do…would be to cut away the drop in payroll tax,” Marshall says, referring to the temporary cuts in payroll tax taken to help people through the recession. If these cuts expire, all working taxpayers would see their taxes increase. “According to the New York Times, households making between 40,000 and 60,000 can expect their taxes to go up by an average of 672 dollars next year [due to increased payroll taxes],” Marshall notes.

Now that we know what is at stake in the fiscal cliff, we can start the debate on how best to avoid it. 

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