Fiscal Cliff: What is this Thing? Can it be Avoided?
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:
- The expiration of Bush era tax cuts on ordinary income and investment income through dividends and capital gains.
- The end of patches to the AMT that prevented low and middle income earners from AMT taxes going back to year 2000 thresholds.
- The expiration of federal unemployment benefit extensions.
- Expiration of Obama era payroll (Social Security) tax cuts.
- Addition of Affordable Care Act tax on high income earners.
- Scheduled federal budget spending cuts to reduce the deficit.
- 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?