Fiscal cliff draws even closer

NEED TO KNOW
  • If Congress fails to reach a deal, $500 billion in tax increases and spending cuts take effect on January 1
  • Taxes would jump an average of $2,400 for families with incomes of $50,000 to $75,000
Fiscal cliff draws even closer

The U.S. economy will be in a heap of trouble if Congress fails to agree on a budget deal by the end of the year. Yes, the end of this year. We’ve been hearing the warnings for months -- going over the fiscal cliff would be devastating to the American economy and the American people. Despite the approaching deadline, the hope for many has been that Congress couldn’t possibly let the nation take the fall for lawmakers' inability to agree on a solution. But finding a solution may not seem so easy when you consider what’s at stake.

So what is at stake? The fiscal cliff refers to more than $500 billion in tax increases and spending cuts that would take effect on Jan. 1, unless congress acts to avoid it. Going over the cliff would most likely result in a slowdown of economic growth, due to a reduction in spending by consumers and by the government. Experts say going over the cliff would impact Americans’ paychecks, 2013 taxes, retirement plans, 2012 tax returns, government spending, Medicare doctors’ pay, unemployment benefits and a range of other things.

The hard part is getting both sides of Congress, as well as the White House, to agree on enough to pass a productive deal. And passing the bill would involve compromising on a variety of controversial issues – including tax breaks for wealthy Americans. House Speaker John Boehner’s recent proposal to solve the problem -- known as Plan B -- was pulled by the Speaker himself without even taking a formal vote, after the somewhat last-ditch effort failed to get enough support.

"The House did not take up the tax measure today because it did not have sufficient support from our members to pass," Boehner said in a statement on Dec. 20. "Now it is up to the president to work with Senator (Harry) Reid on legislation to avert the fiscal cliff."

So less than two weeks before the crucial deadline, lawmakers made their way out of town for Christmas break at the end of last week. President Obama also went on his merry way, but while headed out of Washington, insisted that coming to a compromise by Dec. 31 wasn’t impossible. But with only a few days left and still no deal, Americans aren’t very confident that lawmakers will get the job done.

So what happens if Congress and the White House don’t make a deal before the deadline?

Middle-class tax hike

Millions of Americans are facing a huge tax increase and may not even know it. Millions of taxpayers could become subject to the federal alternative minimum tax for tax year 2012, which means they would most likely face delays in filing their returns, as well as collecting refunds, if Congress doesn't act.

The alternative minimum tax (AMT) was originally aimed at America's richest taxpayers, to ensure they pay at least some income tax. This tax takes effect at a specific income level and carries its own set of rates. Basically, the AMT is supposed to account for all of the exemptions, deductions and credits that wealthy taxpayers benefit from on their regular income tax bill. Taxpayers subject to the AMT must file separate paperwork on their IRS tax return, in order to determine their regular income tax bill, as well as their AMT bill.

Where the problem comes in is the fact that the AMT doesn't account for inflation. When taxpayers' incomes are bumped by a small percent each year, it puts them closer to the income level subject to the AMT. So over time, this tax that was originally meant for the wealthiest Americans has crept into the middle class. And when an AMT payment is required, a taxpayer could end up owing thousands more in taxes.

To keep millions of lower-income Americans from becoming subject to this tax, Congress usually enacts an annual AMT "patch" that temporarily raises the required income levels. Last year, the exempt income levels were $48,450 for single taxpayers and $74,450 for married taxpayers. If Congress fails to reach a budget deal, these levels will drop significantly to $33,750 for single Americans and $45,000 for households. The temporary fix expires Jan. 1, so without Congressional action, there will be no patch, and nearly 28 million more Americans will be subject to the AMT when they go to file their 2012 tax return early next year.

Expiring tax cuts

One of the factors causing much of the controversy involves the George W. Bush-era income tax cuts -– whether the deal would allow those rates to rise for the wealthiest Americans. Several tax breaks that went into effect back in 2009 – as a way to stimulate the economy and help low- and middle-income families -- are also set to expire Jan. 1. The alternative minimum tax would then extend to include about 28 million more taxpayers.

So things could soon get even tougher for millions of Americans who are already struggling. Without a deal from Congress by Dec. 31, taxes would jump an average of $2,400 for families with incomes of $50,000 to $75,000, according to the Tax Policy Institute.

Smaller paychecks mean less spending money -- a bad sign for businesses. On top of that, taxes on investments would rise, while some corporate tax breaks would be allowed to expire. The combination of these factors could cause some major problems for American businesses, and in result, for American jobs.

Government spending

Going over the fiscal cliff would mean cutting a big chunk of government spending -- around 8% to 9%. The areas affected range from military spending to various services provided by the federal government, and the cuts would most likely cause federal workers to be laid off and companies to lose government business. The Congressional Budget Office estimates that up to 3.4 million jobs could be lost in 2013.

Doctors’ payment cuts

Doctors and Medicare patients would also be affected by certain cuts in government spending. A scheduled reduction in Medicare’s payment rates for doctors would lower spending by $11 billion.

Unemployment benefits

Even if a deal is made by Dec. 31, more than 2 million jobless Americans could lose their federal unemployment benefits next year. Those benefits are set to expire on Jan 1. for Americans who’ve been out of work for six months or more (since July 1, 2012). With or without a deal, if Congress doesn’t renew the extension, unemployed Americans will be eligible to receive only 26 weeks of state benefits. That’s a significant drop the 73 weeks of combine state and federal benefits that have been available to jobless Americans this year.

The CBO estimates extending the federal benefits would cost the government $30 billion -- another expense that’s keeping Washington divided. While Obama wants to extend the aid, Republican lawmakers argue it’s too costly to the federal government.

Republicans vs. Democrats

Obama says he won’t agree to a deal unless it includes tax increases for the wealthiest Americans, while Republicans are against raising any American’s taxes. Boehner’s Plan B would have raised taxes only on incomes above $1 million, but he still didn’t get sufficient Republican support.

Spending cuts are another huge dividing factor. Republicans want much deeper spending cuts than those being proposed, particularly when it comes to federal aid programs.

Debt vs. Deficit

The deficit is the difference between the money the federal government takes in and the money the federal government spends each year. When there is a deficit, meaning the U.S. owes more than it brings in, the Treasury has to borrow the money necessary for the government to pay its bills. Government spending has been growing at a dangerous pace, and since 2009, Congress has not been able to agree on a federal budget deal, but instead has just created temporary solutions.

The U.S. is ending the year with a $1.1 trillion deficit. That makes 2012 the fourth year with a federal deficit of more than $1 trillion. When broken down by household, the U.S. government spent about $30,000 per American household in 2012.

While the deficit is an annual-based figure, the federal debt is the total amount of money the U.S. government owes. Each year there is a federal deficit, that money is added to the U.S. debt, which just recently exceeded $16 trillion.

When it comes to solving this country’s federal financial issues, Congress has kicked the can down the road for so long now that even the most ideal bipartisan agreement won’t even come close to resolving the problem. But although things have gotten so bad, we have to start somewhere.

Soft deadline

Although the Jan. 1 deadline is a critical turning point, if a deal isn't passed in time, Americans won't suddenly be lining the streets in despair. Yes, the U.S. economy could be sent into another recession down the road, but there are a few ways Congress can maneuver itself and the country out of the worse-case scenarios.

If a deal isn’t passed before the Jan. 1 deadline, Congress may be able to push off most of the scheduled tax hikes and spending cuts for a couple of weeks, until an agreement is reached. There are also certain tax hikes, such as those included in the expansion of the income tax, which could be reversed retroactively down the road for some taxpayers. So while it isn't ideal, Congress can still solve some of these problems after Jan. 1.

What’s left?

Lawmakers and President Obama are expected to return to Capitol Hill Thursday. Regardless of what happens over the next week, the current Congress is only in session until Jan. 3, which means a group of newly elected lawmakers will likely inherit a mess of a problem.

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