The danger is realized by all sides. Ben Bernanke, chairman of the Federal Reserve, recently warned Congress that the nation is “headed for a massive fiscal cliff.” As reported by The Hill, Bernanke said, “Under current law, on Jan. 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases.” He continued, “All those things are hitting on the same day, basically. It’s quite a big event.”
The root of the problem lies in the fact that Congress has been solving problems with temporary solutions for years. Some recent examples of this include the vote in 2010 to extend the low Bush-era tax rates for another two years and the extension of the payroll tax cut in February 2012 through the end of the year.
Perhaps the most egregious example of kicking the can down the road was the formation of the super committee on deficit reduction in August 2011. The committee was part of a compromise, the Budget Control Act of 2011, which allowed President Obama to raise the debt ceiling and avoid a federal default without making significant spending cuts. The committee’s job was to find a bipartisan path for deficit reduction, but by November the committee announced that its members had “come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee's deadline" according to CNN. As a consequence of the committee’s failure, $1.2 trillion in automatic across-the-board cuts were scheduled to go into effect beginning in 2013.
The problem with these cuts is that they are not targeted to wasteful or unnecessary programs. Because they are general cuts to almost all government programs except Social Security and Medicaid vital programs such as national defense will face draconian cuts unless Congress acts. According to ABC News, half of the $109 billion in annual cuts would come from defense spending. Medicare would also face cuts of up to $11 billion.
The New York Times and the Wall St. Journal provide partial lists of the tax increases that will go into effect on January 1, 2013. These include the expiration of the low Bush-era tax rates which would increase the top individual rate to about 42 percent when the phase out of deductions is included. The capital gains tax would increase to 20 percent from 15 percent today. President Obama’s payroll tax cut for employees would increase by two percent. CBN adds that many temporary fixes, such as those for the marriage penalty and the Alternative Minimum Tax, will disappear at the same time. The child tax credit will be halved from $1,000 per child to $500.
There are also new taxes scheduled to go into effect at the same time. These include provisions of the Affordable Care Act (“Obamacare”) such as an additional 0.9 percent tax on taxpayers earning more than $200,000 and a 2.9 percent tax on investment and interest income.
In all, the Wall St. Journal estimates that investment taxes would see a total increase of about 60 percent within a year. The New York Times notes that the tax increase for a middle-class family earning $50,000 would be almost $2,000. Many low-income families taken off the tax rolls by President Bush’s tax cuts would have to start paying taxes again as well.
The only way to avert the coming catastrophe is for Congress to act. Given the past history of the current divided Congress, action is not likely to be forthcoming before the election. Republicans are willing to reform the tax system, but have proven unwilling to bow to Democratic pressure for tax increases. For their part, the Democrats have proven resistant to the smallest spending cuts even though spending is at record-high levels for peacetime.
If a deal is not made before the election, the matter will go before the lame-duck Congress and, possibly, a lame-duck president as well. If the Democrats lose control of the senate and Mitt Romney becomes the president-elect, President Obama and the current crop of congressional Democrats could still force the nation’s taxes to rise sharply by simply failing to act. The new president and Congressmen would not take office until late January 2013, too late to stop the automatic tax increases and budget cuts.
What this means is that even if President Obama is not re-elected, he can force the country to pay higher taxes simply by doing nothing. At the same time, he could likely avoid much of the blame for his actions. He would be out of office by the time the tax increases were felt and the economy faltered. Aided by the media, he could deny culpability and blame the incoming administration and Congress even though they never had a chance to address the problem.
These tax increases would be far more extensive than the Buffett Rule tax on the wealthy that the president has been pushing. For all the hype, the Buffett Rule would not produce enough revenue to pay for even one percent of President Obama’s federal budget according to an analysis by the Senate Finance Committee. Theoretically, the 2013 tax increases would produce more revenue, but this does not take into account the fact that they would cause the economy to slip back into recession. As profits fall, so would tax revenues.
The longer the delay in resolving the Taxmageddon problem, the more likely it is that the economy will suffer the consequences. Businesses plan investments months or years in advance. If it appears that there will be massive tax increases at the beginning of the year, businesses will defer investments and move money into tax shelters as the date of the tax hikes approaches. This would mean fewer jobs and less spending throughout the economy. The longer Congress takes to address the looming issue of Taxmageddon, the more likely it is that the nation will again face economic hard times, regardless of who wins the election.
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