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Home » Personal Finance News

Fiscal Cliff: What is this Thing? Can it be Avoided?

Last updated by on 8 Comments

Now that the election is behind us and 2014 campaigning has begun, just about every political news story of late revolves around the impending “fiscal cliff”.

Ah, yes, the “fiscal cliff”. An impending smorgasbord of automatic expiring tax cuts, tax increases, and spending cuts all scheduled to happen at the end of this year, which will send the U.S. economy driving off a cliff and ending in a charred and mangled catastrophe, thousands of feet below.

If only the soft top on our convertible could pop open, acting as a parachute so we could all safely float to the bottom (first person to name the 80’s movie reference wins my respect).

All joking aside, the individual impact of a complete fiscal cliff has far reaching implications for our personal finances. Just about everyone will be impacted by tax changes of some kind. If you’re not familiar with what it is, I’ll try my hardest to explain…

What Exactly is this Fiscal Cliff?

The fiscal cliff is a combination of:

  1. fiscal cliffThe expiration of Bush era tax cuts on ordinary income and investment income through dividends and capital gains.
  2. The end of patches to the AMT that prevented low and middle income earners from AMT taxes going back to year 2000 thresholds.
  3. The expiration of federal unemployment benefit extensions.
  4. Expiration of Obama era payroll (Social Security) tax cuts.
  5. Addition of Affordable Care Act tax on high income earners.
  6. Scheduled federal budget spending cuts to reduce the deficit.
  7. A decrease in the amount of estates exempt from taxes.

Is this thing serious?

Its impact has been debated, but the Congressional Budget Office (independent budget arm of Congress) predicted that the fiscal cliff would cut economic output by 0.5% in 2013. In a nation obsessed with continuous growth, that’s not good, but it’s been modeled that the cuts/revenue would actually result in lower unemployment and higher growth in the long run, but … FISCAL CLIFF!!! We don’t care about the long run, we’re the United States!

So how did we get in to this situation? For some insight, lets review the election results and balance of power in Congress.

The Congressional Balance of Power & Election Leverage

Prior to this year’s election, Democrats had a (non-super) majority in the Senate (51 to 47), while Republicans held a majority in the House (242 to 193). In scenarios where one side of Congress has a party majority, while the other side has an opposing party majority, it’s extremely difficult for major agreements to get pushed through, particularly when it comes to taxes and budget spending.

The result is you have all of these deadlines that were being pushed back because no previous long-term agreement could be reached.

Did this election shake things up to change the balance of power that led to the impasses? Lets review the final election tallies:

  • Electoral Vote: Obama defeats Romney 332 to 206
  • Popular Vote: Obama defeats Romney 61,910,594 (50.6%) to 58,654,765 (47.9%)
  • Senate: Democrats increase majority from 51 to 53 of 100 seats (2 additional senators are independent but vote with Democrats)
  • House: Democrats picked up a net 8 additional house seats, but Republicans hold the majority 233-194, with a number still being re-counted

Obama and Democrats believe that they have negotiation leverage to push through the tax changes that they would like with the Obama victory, the popular vote, and increases in the Senate and House.

House majority speaker Boehner and Republicans believe they have negotiation leverage in that they weren’t completely over-run and still have a majority in the House.

And this is what it the fiscal cliff comes down to. There was no sway of power from one side to the other with the election results. Republicans have stuck to the same message they have over the previous four years – “we will not approve any new taxes”, while Democrats believe we need a mix of new revenue (primarily by letting most Bush-era tax cuts expire) and spending cuts. Without a bi-partisan agreement in the House, any proposal by Democrats would not receive enough Republican votes to pass the House.

What Democrats and Republicans Want

Neither side wants to see AMT tax increases. And neither side wants to see tax increases for those families making $250,000 and under. Hopefully, at least that much is worked through.

Beyond that point of agreement, it is expected that the payroll tax cut – a temporary stimulus to the future detriment of Social Security – will probably expire without much fight.

And with the Affordable Care Act (Obamacare), starting in 2013, high-income Americans will pay an additional tax of 0.9% on their earnings above $250,000 if they are married and above $200,000 if filing single. They will also pay an additional 3.8% on capital gains, dividend, and interest income. Republicans oppose these increases, but with Obama’s re-election, Obamacare changes are likely to stick.

The main point of dissent is that Obama and Democrats want the tax cuts for those making $250,000 and above to expire while Republicans do not. Republicans also oppose a rise in estate taxes. Currently $5M is exempted, but it will expire to $1M. Democrats believes it should be set at $3.5M and indexed to inflation.

And that’s where we are at. And now you can have fun debating.

Fiscal Cliff Debate:

  • What result do you hope to see from any negotiations or do you hope we just fall off the cliff?
  • What result do you actually think will happen? And how are you preparing for it?
  • As a Republican or Democrat, what would you be willing to compromise on?
  • Does either side have a “mandate” of the American people with election results?

About the Author
I am G.E. Miller, & this is my story. My goal is financial independence ASAP. If you share that goal, join me & 7,500+ others by getting FREE email updates. You'll also find every post by category & every post in order.


8 Comments »
  • William @ Drop Dead Money says:

    Excellent summary! My personal take is: if ever there’s a good time for raising taxes and cutting spending, ’tis now. Not from a political viewpoint, but from a strength of economy standpoint.

    What’s been lost in the sea of negativity regarding the economy, is the “private economy” has actually been growing for the past few years. The biggest drag on reported GDP is the decline of government spending.

    Yes, you read that right. Government spending has been in decline now for close to a decade. The key is to remember that state and local government spending dwarf Federal spending. Non-federal government entities for the most part can’t deficit spend, so when their revenues shrink, they have to cut expenses. And these expense cuts have been the biggest single drag on GDP growth for the past 5 years or so.

    Take that away, and the rest of the economy shows surprising strength. And the best time to cut government spending is when the rest of the economy is there to pick up the slack. (Remember Clinton’s military base closings? That reflected budget cuts in a growing economy and it worked very well.) Others may argue, but I believe the U.S. economy is beginning to hit its stride and once the artificial “pre-cliff” business and personal decisions are behind us, the economy will surprise us with its ability to absorb the compromise that will be adopted.

  • mdenis39 says:

    You mentioned the Estate tax is to be indexed for inflation. How about any other of the taxes already in place? Will we have another AMT fix every year starting 20 years from now?

    We need to get rid of ALL loopholes in the tax system & simply institute ONE tax rate for all income – div, cap gains, income, interest, etc. The system is ridiculously complex and getting worse every single year.

  • N/A says:

    G.E.

    Sorry to hijack this discussion, but I was curious about an earlier post you made and I can no longer find that post. Did you ever get your bonus gift card for buying the $200+ american express prepaid card? Still waiting here…

  • The fiscal cliff is an important issue and will be a telling sign of how the next four years will proceed. Republicans are stating that the current amount of revenue derived from taxes currently is more than at any other time in our nations history (in terms of dollars, not percent of GDP). I am not trying to argue for or against Republicans or any other party or viewpoint, only to mention that in the coming months half-truth “facts” such as this will be thrown around with a frequency rivaling only radio waves. Truth is, as the economy grows so will tax revenue; and even if the percentage of revenue is held flat historically, there would still be an increase in dollars collected 15% of 100 is not as much as 15% of 1000. Its math, man.

    Don’t let veiled lies such as this (from either side) dilute the issues and truths.

  • E Smith says:

    Movie reference: PeeWee’s Big Adventure ?

    This was a great summary of a confusing topic. I must admit that the deficit is what scares me the most, but I have little hope of the two sides working toward a solution.

  • Matt says:

    With Obama in office and a democratic Senate, I’m guessing Democrats will let the tax cuts expire, but simultaneously push for a bill to reinstate the tax cuts for the middle class (people/couples making less than $100,000/$250,000). This is brilliant politics: Democrats will be forcing republicans to vote AGAINST a tax cut for the middle class, which is a tough thing to do politically (they won’t). Obviously, it’s economic nonsense, but that’s beside the point. So, in effect, the middle class will get the tax cuts extended, and the rich won’t. Either way, we can’t afford it if we don’t do anything about the spending/debt.

    The spending cuts are less predictable. My guess is not much will be cut. I don’t think Obama or Congress will cut much military spending, both as a concession to Republicans and because of the Benghazi stuff. And they’re obviously not going to cut ANY social entitlement spending. Even Romney likely wouldn’t have touched those much, let alone Obama. That brings us to the debt ceiling.

    In order to be able to afford all this free shtuff, (ie SS, Medicare/aid, extending tax cuts to the middle class, etc.) without cutting any meaningful spending from the federal budget, the debt ceiling will have to be raised, again, as usual. What’s going to happen is that all of the members of Congress are going to express outrage about it, talk about how we spend too much, and then of course vote to raise the it because they’re economically and logically challenged. Democrats will say we spend too much on military, Republicans will say we spend too much on entitlements, and they’re both right. Nothing will get cut, and we’ll just take on more debt from China, Japan, etc., to finance it all, and the Fed will obviously “help” out by printing money. In fact, none of this national credit card-roulette would be able to happen without the Fed.

    Buy gold, oil, land with water rights/food. Stay out of the dollar, and acquire skills outside of service industries. The real fiscal cliff isn’t the one at the end of this year: it’s when interest rates rise.

    • Ben says:

      Well put, Matt. I think I would rather us go off the cliff to restore some sense of fiscal responsibility. Printing money, borrowing money, and relying on some large uptick in the economy seems irresponsible. It is time we all start to realize that a sustainable government is an important piece of our country and economy’s stability. Maybe that doesn’t mean everyone is entitled to certain benefits (e.g. Social Security) and maybe that the government can’t support a enormous budget for discretionary spending. I don’t know the answer but I do know we cannot repeat the last 10 years of deficit runs with the same economy.

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