What Makes Up the Fiscal Cliff?

September 12, 2012

Much is in the news recently about the Fiscal Cliff.   Commentators say the US economy will dive unless Congress reverses prior actions that result in tax increases and spending decreases that for the most part become effective at the beginning of 2013.   The Congressional Budget Office estimates that the combination of tax increases and spending cuts will reduce the nation’s deficit by $560 billion in 2013 and by $7.1 trillion over the next ten years.  But it also estimates that the $560 billion in tax increases and spending decreases in 2013 could take several percentage points off of economic growth.       Included in the tax increases are:

  • Increases in individual income tax rates from 10, 15, 25, 28, 33 and 35 to 15, 28, 31, 36 and 39.6
  • Reinstatement of the phaseout of the personal exemption (the phaseout reduces the value of each personal exemption by 2% for each $2,500 or part thereof above specified income levels, starting at $261,650 for those married, filing jointly, at $174,450 for those filing single)
  • Reinstatement of the phaseout of itemized deductions (the phaseout cuts itemized deductions by 3% of adjusted gross income above specified levels-beginning at $174,450-but not by more than 80%)
  • Increase in long-term capital gains rates from 15% (or from 0% for those in the 10% or 15% bracket) to 20% (or 15% for those in the 15% bracket)
  • Increase in tax rate for qualified dividends from 15% to the taxpayer’s regular tax rate (the distinction between ordinary dividends and qualified dividends-those on stock from a domestic corporation or a qualifying foreign corporation that you have held for a qualifying period-disappears)
  • Reduction in amount of income exempt from the Alternative Minimum Tax from $78,750 to $50,600 for those married, filing jointly, and from $45,000 to $33,750 for those filing single.   Commentators estimate that more than 30 million people will pay the AMT, as contrasted with 4 million in recent years.
  • Increase in social security tax rate back to 6.2%, from 4.2%, on the first $110,100 in wages
  • Reduction in estate tax exemption to $1 million from $5 million, and the top estate tax rate goes to 55% from 35%
  • Other increases result from reductions in the child tax credit, the earned income credit, educational credit and savings provisions, reduction in the student loan interest deduction and expiration of enhanced depreciation provisions.

In addition to tax increases, automatic spending cuts are scheduled to begin at the beginning of 2013.  These require cuts in 2013 of $55 billion from defense spending and $55 billion from nondefense programs.  Experts estimate that these numbers represent approximately 10% of the defense budget (except for portions exempt from the cuts) and 8% of the nondefense budget (except for portions exempt from the cuts).   In addition to the spending cuts and tax increases that make up the fiscal cliff, the new 3.8% tax on investment income applies beginning in 2013, see here, as does the new 0.9% tax on wage income over $250,000 for those married filing jointly, or over $200,000 for those filing single.   There is talk of a compromise under which some of the tax increases would be deferred, but most commentators think that nothing will happen prior to the November elections.