Since the presidential election, attention has turned to resolving deficit negotiations to prevent the U.S. from going over the "fiscal cliff” on January 1. So what exactly is the fiscal cliff and what would going over it do?
The term “fiscal cliff” was coined by Federal Reserve Chairman Ben Bernanke, in testimony before Congress earlier this year. He warned that unless Congress reached agreement on a new deficit-reduction plan, the economy would take a very nasty spill.
A year ago, when Congress was at loggerheads over raising the debt ceiling, the two sides agreed on a temporary solution by putting in place a set of deep government spending cuts to go into effect January 1, 2013, when the “Bush” tax cuts, passed in late 2001, expired.
Unless Congress came up with an alternative plan, the net result would be a steep increase in everyone's taxes and a sharp drop in government spending. It was agreed to because it was so drastic it was supposed to nudge Republicans and Democrats from their dug-in positions and make them more agreeable to compromise, to head off what economists say would be a calamity.
Here's what is scheduled to happen on January 1: the “temporary” tax cuts put in place in the wake of 9/11 would expire, meaning everyone's taxes would revert to what they were before that time. While not technically a tax increase it would feel like one, since everyone would pay higher taxes.
Economists are worried about the impact because of the weakness of the economy. A tax burden that was seen as affordable during the booming economy of the late 1990s might push the U.S. back into a recession now.
However, President Obama and Democrats in Congress say upper income taxpayers, families earning over $250,000 a year, should have their taxes revert to the old, higher rate while everyone else's stays the same. Throughout the campaign Obama said upper income households “should pay a little more” because they can afford it.
Now that the president has won another four-year term, he and his allies see no reason they should retreat from that position. Republicans, however, have dug in their heels insisting that no one's taxes should rise.
That's the stalemate. House Speaker John Boehner (R-OH) says Republicans would agree to raise government revenue but only by closing loopholes and deductions, not by raising rates. Ever since President George H.W. Bush said “read my lips, no new taxes, ”then later agreed with Democrats to raise taxes and went on to lose re-election, no Republican has been willing to support a tax increase of any kind.
Democrats, meanwhile, never liked the tax cuts passed under President George W. Bush, but concede taxes can't be raised on most households that are struggling to make ends meet. However, they have said there is no reason rates can't be raised on families earning $250,000 a year or more.
That's how we got to the edge of the cliff, but what happens if we go over. First, the tax consequences.
The current 10 percent tax bracket, for the lowest income taxpayers, would revert to 15 percent. The 25 percent tax bracket would rise to 28 percent; the 28 percent bracket would rise to 31 percent; the 33 percent bracket would rise to 36 percent; and the 35 percent bracket would rise to 39.6 percent.
That final tax bracket -- the 35 percent to 39.6 percent -- is what the stand-off is all about.
How would you be affected? If you fall within the category of a “middle income” taxpayer, the non-partisan Tax Policy Center estimates you would pay about $2,000 more in taxes next year, including the end to the two-year payroll tax cut, which no one is talking about extending.
Because consumers would have less money to spend, businesses would likely cut costs as well and many jobs might be eliminated. The Congressional Budget Office estimates 3.4 million jobs could be lost pushing the unemployment rate past nine percent.
Government spending cuts
The other part of the fiscal cliff is a set of pre-programmed across-the-board government spending cuts. Defense spending would fall 10 percent. Spending on domestic programs would drop eight percent, though in the way Washington looks at spending, a reduction in the planned increase in spending is considered a “cut.” In terms of actual spending, it's been estimated the overall spending would revert to around 2007 levels. Still, in a weak, recovering economy, the impact would be felt.
Is there any way to avoid going over the cliff? Probably. Negotiations have already begun with Republicans and Democrats displaying their best poker faces.
Weekly Standard Editor Bill Kristol, an intellectual voice of the conservative movement, raised his fellow Republicans' blood pressure by suggesting it wouldn't hurt to raise taxes on millionaires, pointing out most probably voted for Democrats anyway.
Sen. Patty Murray (D-WA) also floated a novel idea this week, suggesting it wouldn't be so bad if we in fact went over the fiscal cliff. She pointed out that once tax rates had reverted to their higher rates, Republicans would likely join Democrats in quickly voting to cut taxes for low and middle-income earners.
Taxes on upper income earners would remain the same. That way, she pointed out, Republicans wouldn't have to vote for a tax hike but Democrats would get the higher rates on upper income taxpayers that they want.
Perhaps because of the pain the fiscal cliff would cause, no one has mentioned the one benefit going over it would bring; the federal deficit, which has mushroomed in recent years, would get smaller.