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Ways of the World

Carol Stone, business economist & active Episcopalian, brings you "Ways of the World". Exploring business & consumers & stewardship, we'll discuss everyday issues: kids & finances, gas prices, & some larger issues: what if foreigners start dumping our debt? And so on. We can provide answers & seek out sources for others. We'll talk about current events & perhaps get different perspectives from what the media says. Write to Carol. Let her know what's important to you:

Tuesday, January 08, 2013

Pulling Back from the Fiscal Cliff

In extraordinary New Year's Eve and Day sessions, the U.S. Senate and House of Representatives passed H.R. 8, a bill that prevented some of the tax increases and spending cuts that have been known as the "Fiscal Cliff".  Had they not achieved agreement late New Year's night, the scheduled budget actions had been predicted to push the economy back into recession.

We wrote about this in late October, a couple of weeks before the election.  We expected then that the post-election lame duck Congress would merely pass some stop-gap measure to prevent the January 2 changes from taking place and leave the new incoming Congress the job of really fixing the federal government's fisc.  This is close to what happened, although many analysts and policymakers in government and on Wall Street seem disappointed as they assess  that some major opportunity to effect desired structural reforms was lost.  Wall Street traders and investors were relieved, though, that anything at all got accomplished, and stock markets surged strongly the following day.

We'll try to explain a bit of what was done and what was in fact left for the new Congress.  New deadlines were established, and they'll come up very soon.  Decisive action will still be needed within just the next few weeks.  Hopefully, what was done last week helped lawmakers experience a sense of "compromise" so that they might be able to do that again.

First, on taxes
1.  The expiring Bush tax cuts were made permanent for taxpayers with incomes below $400,000 (single filers) and $450,000 (married couples).  Rates for those with higher incomes rise to 39.6% from 35% for ordinary income, and their rates on capital gains and dividends move from 15% to 20%.

2.  The Alternative Minimum Tax (AMT) was repaired permanently.  This was originally imposed to prevent very high income earners from avoiding taxes altogether through the use of loopholes.  This worked.  But the threshold it used for "high income" was never adjusted to allow for inflation or overall growth of the economy, so sizable numbers of middle income taxpayers were moving into the range where it would apply, subverting the benefits of regular deductions and exemptions for them.  So fixing this was very beneficial.

3.  The federal estate tax rate was raised from 35% to 40% on estates larger than $5 million.  Those below that amount have been exempt from the federal estate tax and remain so.

4.  Various refundable tax credits, such as "Making Work Pay" and the "Earned Income Credit" were extended for five years.

5.  Old provisions that phase down deductions and exemptions for high income earners have been reinstated for single taxpayers with incomes above $250,000 and couples above $300,000.  While aimed at those high incomes, this will also hit a sizable number of upper middle income taxpayers in high-tax states such as New York, California and Massachusetts, who benefit noticeably from being able to deduct their state and local income taxes from the income on their federal returns.  There may also be an impact on charitable giving for those in high income brackets, and that remains to be seen, of course.

6.  Finally, on the personal level, if you have already received a paycheck in 2013, you know that your social security payroll tax went back up.  We had a 2% break on that from 2011 through 2012, but the break has now ended, and those taxes are returning to 6.2% from 4.2%.  Further, the new Affordable Care Act imposes a 0.9% Medicare surcharge on wages greater than $200,000; this was in place already and was not part of the fiscal cliff actions last week.

7.  Also, some expiring business tax cuts for businesses, especially on depreciation expenses, were extended.

So, got that?  Every worker's taxes are going up a little and that's showing up already in payroll tax withholding.  Other tax increases focus on high income earners, although some upper middle income people will feel the impact of the deduction and exemption phase-out.

On the spending side, Congress only tackled a little and that hardly involved much cutting.  Indeed, extending the 99-week availability of unemployment insurance adds to spending, by an estimated $30 billion this year.  Also, a perennial spending issue, a cut in Medicare reimbursements to doctors, was postponed yet again.  Called the "doc-fix," it would add $25 billion to spending relative to what was scheduled, but some other small items were cut enough to offset that in total.  Other postponed cuts are those for the so-called "sequester", an across-the-board reduction in defense and nondefense expenditures, that would have kicked in on January 2; those cuts will now occur beginning March 1, unless further action is taken in the meantime.  Here too, the total impact of the postponement will add $25 billion to spending and that will also be offset by other small reductions.

Totals and Interest
All together, the tax increases are estimated to net $545 billion in revenue over ten years and all the spending provisions together would cut $20 billion.  The deficit would thus be directly reduced by $565 billion.  However, the resulting smaller deficits would mean less borrowing, so interest charges on the debt would also be reduced; these are projected at $85 billion over ten years.  The sum of these changes is deficit reduction of $650 billion out to 2022.[1]

You're seeing some reports that argue that this legislation adds to the deficit.  It does add to the deficit that would have occurred if the government had instead gone over the fiscal cliff, with all the tax cuts expiring and all the spending sequester and other provisions taking effect January 2.

As these numbers indicate, the dollar amounts of the changes enacted in the quickly produced anti-fiscal-cliff legislation leave a great deal of work to be done in just the next few weeks, or those dramatic "sequester" spending cuts will take place and/or deficit reduction will amount only to the minimal amounts we've described here.  Further, none of this does anything about long-needed entitlement reform.

It is disappointing that the only time anything of substance can happen is when the Congress is up against some dramatic deadline.  As midnight loomed on January 1, only then did real agreement take place.  And the time pressure didn't prevent some doozies from getting in among the provisions: special subsidies for Hollywood film producers who shoot movies in depressed neighborhoods and an accelerated depreciation deduction for operators of NASCAR racetracks, to name two.  Really?  Really.

Debt Ceiling
There is also a debt ceiling deadline.  The federal government's debt reached the current legal debt ceiling of $16,394,000,000 on December 31.  Special intergovernmental switching of balances among various accounts can enable the Treasury to borrow fresh cash in the markets until about February 28 to cover the ongoing deficit.  But after that, spending must be held to the amount of revenue.  Early March social security checks, for instance, could be reduced if there is no action to raise the debt ceiling.

Such debt ceiling bills are often occasions when special interests cash in their biggest chips.  The bills must be passed to prevent such spending cuts and/or outright default on debt that comes due and cannot be refinanced.  So March 1 is a kind of "drop dead" date for federal government finances: both the postponed spending sequester and the debt ceiling will slam head-on into the government spending machine.

This article is already too long and we have not gotten to our own prescription for actions we wish Congress – and the President – would take to alleviate these tight conditions.  Probably once again, it will be too much to expect that thoughtful discussion about government spending priorities and entitlement reform could be accomplished so quickly.  These are serious issues, and simply – as some urge – raising taxes again will only kick the spending can further down the road.  Federal government spending must be rationalized.  Obviously we will have to talk about this some more.  And we will – very soon!

[1]The numbers in this article come from the independent and bi-partisan Committee for a Responsible Federal Budget, at  Among its board members are Erskine Bowles and Alan Simpson, who chaired President Obama's deficit commission in 2010.   Some of CRFB's projections come in turn from another similar group, the Bi-Partisan Policy Center, .  These groups are distinctive for including mainstream analysts from both parties, for example, CRFB's board also includes Alice Rivlin, the very first director of the Congressional Budget Office, and David Stockman, budget director in the Reagan Administration.

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