What is the “Fiscal Cliff?”
- By Simple Politiks
- 28 August, 2012
- 8 Comments
For the past week or two I’m sure you have heard something about the “Fiscal Cliff” on the news. Here’s a basic summary in case you’re still curious.
Basic idea: if our friends over in Washington can’t address a series of spending cuts and tax increases then there is a chance that we could be thrown into another recession. That concept seems a little crazy until you realize we’re talking about a total of $7 trillion worth of tax increases and spending cuts. So what specific spending cuts and tax increases should we look out for?
The Budget Control Act – $1.2 trillion in deficit reduction over 10 years. This goes into effect because Congress has failed to reach a bipartisan debt-reduction deal.
Defense – $55 billion will be cut in 2013 (roughly 10% of every program). I don’t think this one is as crucial because just 10 years ago our military budget was 100s of billions lower. Still, the cut is significant in present day.
Nondefense – $55 billion will be cut to departments/programs like education, food inspections and air travel safety. Estimations say at least an 8% cut to programs, projects and activities.
Bush Tax Cuts – All of the Bush tax cuts are set to expire December 31. This results in income taxes going from 10%, 15%, 25%, 28%, 33% and 35%…. To 15%, 28%, 31%, 36%, 39.6%. Nobody likes taxes… Could be necessary considering our debt and deficit situation, though. Regardless… all of the taxes that follow are caused by these tax cuts expiring:
- Capital Gains Rate: Rises to 20%, used to be 15% for most fliers.
- Qualified Dividend Rate: Rises to one’s top income tax rate, up from 15% for most fliers.
- PEP/Pease Limitations: Restored, making high-income households unable to take some itemized deductions and personal exemptions in full (not in every case).
- Child Tax Credit: Falls to $500 per child (used to be $1000). The amount permitted for a refund is also reduced.
- American Opportunity Tax Credit: Expansion of eligibility for the credit expires.
- Marriage Penalty Relief: Expires. This means that low- or middle- income two-earner couples will owe more to the IRS than they would if they were single and making the same income.
- Estate Tax: Parameters return to pre-2001 levels. Exemption level used to be $5 million, falls to $1 million. The top tax rate on taxable estates used to be 35%, rises to 55%.
AMT patch – This will not be renewed, it was for income exemption from the Alternative Minimum Tax. Individuals and married couples used to get the following exemptions, respectively: $50,600 and $78,750.
Now they get this amount, respectively: $33,750 and $45,000
As a result more than 30 million people will be included in the “wealth” tax. Only 4 million people used to be included.
There is a bipartisan bill from the Senate Finance Committee which proposes a patch for 2012 and 2013. Unfortunately, the bill has not passed the Senate or the House yet. Doesn’t look good.
Payroll Tax Holiday – Expires. Social Security tax reverts to 6.2%, used to be 4.2%, on the first $110,100 in wages. What this means is someone making $50,000 will essentially pay another $1,000 in payroll taxes next year.
Unemployment Benefits Extension – Federal extension expires. Workers who lost their jobs were able to get as much as 99 weeks in state and federal benefits. Once this expires, they will only receive up to 26 weeks. In my opinion, 99 weeks is way too long. I haven’t done enough research to say anything other than that, but it certainly seems excessive. I suppose the recession makes it more reasonable, though.
Tax Extenders – Many business and smaller individual tax breaks will expire. There has been a bipartisan bill to extend many of them. Unfortunately (again), it has not passed the Senate or the House at this point in time.
Medicare Doc Fix – Expires. Medicare payment rates for physician services drops by 27%
Medicare Surtax – Some budget experts count this as part of the fiscal cliff. I didn’t have to add it, but why not? The surtax is on high-income households under health reform.
A 0.9% surtax will apply to wages on earned income over $200,000 ($250,000 if married). That’s on top of the 1.45% Medicare currently owed on all wages. Those making between $200,000 and $500,000, for instance, will only pay about $633 extra while households making $1 million or more would pay another $11,242.
A 3.8% Medicare surtax will also apply for the first time to at least a portion of high-income households’ investment income.
Here are some CBO projections in the event that all of these policies are allowed to go into effect. These are projections and, honestly, I wouldn’t be surprised if they were downplaying some things. That tends to happen a lot. I’m not qualified to give you any hard evidence or professional opinion, though, so just ignore that 
.
- Economy will shrink by 0.5% between the fourth quarter of this year and the fourth quarter of next year.
- Unemployment (currently 8.3%) will rise to 9% in the second half of 2013.
- Another recession
- Deficit will hit $1.1 trillion this year
- For 2013, deficit would fall to $641 billion (biggest single year drop in the annual deficit as a percent of economy since 1969)
- Deficits would continue to fall drastically through 2018. They would begin to rise again as the costs of supporting an aging population begin to take hold.
- Debt projection: 58.5% of GDP in 2022, it is currently 73% of GDP (projected for this year)
Copyright © 2013 
You are correct about all of this. The truly disturbing part is that ALL of our politicians are well aware of these facts (Republicans and Democrats alike) and both sides are playing a childish game of chicken. Each side hopes to win the White House and the majority in each house of Congress, even if only by the most razor-thin of margins, and call it a “mandate” from the public that justifies adopting their respective philosophical “vision” for America without pause or compromise. Until the winner is declared by 50.01% of the vote, nothing will be done.
The reality, however, is that both sides are right and both sides are wrong in their myopic viewpoints and visions. Neither the right’s plan nor the left’s plan will work in the end. If only those “in power” would actually listen to the advise of actual objective experts in the field, recognize that life requires and exacts a balance in all things in the end, and internalize the basic philosophy that today’s populous has regarding the structure and foundation of the nation in which we live.
These realities are that the truth usually lies somewhere in the middle (this insight comes from someone whose day job has been spent as a lawyer for nearly 15 years) and that neither Plato nor Aristotle had it completely right.
There are some principles that are absolute, as Plato advocated, and these basic principles in our American life are easily identified — they are those principles that were set forth in our Declaration of Independence and our Bill of Rights. While the Constitution is intended as an embodiment of these ideals, it also is largely intended as a governing document, like Articles of Incorporation and a Shareholder Agreement are to a modern day corporation. But, Plato dealt in principles. The devil, however, is always in the details.
In the context of this discussion, the devil is the “how”, how will these principles be implemented in a large, dynamic, and diverse populous of divergent people with divergent views and needs. For the answers to these questions, we must turn to Aristotle and the rule of the golden mean. While Plato stood for the principle than no one life was worth any more or any less than any other life, Aristotle believed that the goods of the many outweigh the goods of the few or the one.
Enter Jean Jacques Rousseau and The Social Contract. In the simplest of terms, this political philosophy posited the idea that the individual has a much greater chance of survival when joined with a larger group of people, that there is, in essence, safety in numbers. I am really good at some things, but I can’t fix a busted pipe in my house or put out the flames if my house catches on fire. So, I join a larger societal group with others who can utilize the skills and strengths that I possess in exchange for the skills and strengths that the others can provide to me that I do not on my own possess.
In order for there to be a functional harmony in this larger group of distinct individuals with different backgrounds, skills, beliefs, and point of view, we each must be willing to voluntarily opt not to exercise our individual right to do anything and everything that we might chose if in so doing we would infringe upon the rights of any other individual in “our group”. So, while I may be free as an individual to say anything I damn well may like, I must also consider the rights of my fellow citizens not to be exposed to or participate in that exercise. So, rather than plaster my words in paint all over the front of my house where my neighbors cannot avoid having their children see it, I express myself in forums that they can avoid reading if they chose.
In the end, it all comes down to defining what are those few absolute principles that can neither be bent nor broken (such as the right to life, liberty, and the pursuit of happiness) and the rules that govern our everyday world. In fashioning the latter, both Aristotle and Rousseau would tell us that there MUST be compromise, a balance between the rights of the few (or the one) and the interests of the many.
It is a tragic misfortune that both of the two major political factions in our country today seem to have completely lost sight of both the principles upon which our nation was founded and on the tempered and balanced wisdom that is at the very essence of good leadership. Both parties have done nothing more at this juncture but prove the old adage true: that power corrupts and that absolute power corrupts absolutely.
I could give you a lot of practical answers to solve all of the problems mentioned in the above blog post, as could a great many people. The problem is that the people in power are no longer listening. The system has silenced all other voices, save these two extremes.
Interestingly, it has only been during the course of the past one hundred years (give or take) that we have had a iron-fisted two-party system. I am not naive. I know that the landed gentry and the oligarchy were the ones who founded our country and they have always been in control, usually standing behind the curtain pulling the strings.
But, out of their own greed and in fear of the King of England taking away their power and wealth, a miraculous little thing happened — an oversight, really. In their short-sighted attempt to spurn the common man to pick up his musket and sacrifice his own life and that of his children to fight the King, they vested the power in “we the people” in our nation’s founding documents, a power that they never technically rescinded.
The day may well be upon us to exercise that power that our founders never really intended to bestow upon the common man, not really. I am not in any way advocating a revolution. The wise man defeats the system best by using it to his advantage. If it is a system that you believe in, then the ethical approach is to follow the rules of that system to change the things that need to be changed. It is OUR system and it time that we took it back from the few that have corrupted it before our very eyes with such impunity.
I say this with all the love in my heart. More than half of those landed gentry who signed the Declaration of Independence in order to protect their own interests were my direct ancestors. While their motives were almost certainly not entirely pure (whose intentions among us ever really are), they did — whether purposefully or by short-sighted accident — give us all the power, collectively, to say no.
So, this particular election, with the stakes so potentially grave, I will do my part. Against my own interests and with every expectation that the vote I cast may put the worst candidate of the two party system in office, I will be voting for every third party candidate on the ballot. For each race where there is no third party alternative, I will either leave the box unchecked or write-in a candidate. If that invalidates my ballot, then so be it.
Neither extreme position that we are being offered this year has a mandate. The only mandate that they should be hearing from us is that both sides are wrong in their extreme views, that we are not a nation of 50.01%, and that is actually the people that have the power of the purse, not Congress.
If it means the stock market goes from 12,000 plus to 12, unemployment rises above 50%, and the government’s tax revenue plunges precipitously, then so be it. It will be painful, but “we the people” will survive. We will start our little businesses in our basements, repair roofs in exchange for food, assist someone with their legal affairs in exchange for housing, mend their broken bones in exchange for repairing our car. While “barter” such as this may technically be taxable income, how effectively can they “audit” us when they don’t have enough tax revenue from traditional, corporate employment to hire and maintain IRS agents.
I am not specifically advocating any of this, but It’s a thought. The point is that the system, in its basic form, is a good one. But, it has been allowed to be continually corrupted over time. The cooler heads that once prevailed are gone from public service now in large part. True leaders probably are not made, they are born. However, members of Congress are a different story.
Perhaps if serving as a member of Congress was dealt with more like jury service, with any one of us registered voters getting picked out of the pool and sent to do our civic duty for two years with a very modest stipend (which is not a lot unlike the way it was done in the early days of our nation), then maybe the system would work a little better than it does currently. I have also heard it said that one of the problems in today’s state and federal legislative bodies is that there are not enough lawyers in the bunch. While a lot of people hate lawyers, the reality is that lawyers understand very well that there are at least two sides to every story, more than one plausible outcome, and, therefore, that negotiation and settlement are almost always better than a knock down, drag out fight. And, if they are not getting paid by the billable hour, then they will reach a quick settlement every time.
Wow. I can happily say that I read every word of this response! Thank you so much for writing it, the entire piece was a great read. I completely agree with your statement amount extremes never being truly right. Most of the people in our society are not the extremists. Unfortunately, they always find their way into politics and impose their views… If our economy truly recovers then I think the political atmosphere will get a little less tense and we will slowly gravitate towards the middle again. But right now we’re so polarized that it makes me sick. One side doesn’t have all of the answers… That’s just a fact of life and it should be common sense for our friends in Washington. Still, it evades them.
Thanks again for your post. Hope to see you around.
Great post… makes me think of the Neils Bohr adage (supposedly attributed to him) “prediction is difficult, especially when it comes to the future”.
In regard to your point that passing the necessary legislation to avoid the fiscal cliff would avoid a short term crisis but would be prohibitively expensive in the future… 1) better to pass the legislation in the near term and avoid short term potential for collapse (if that is indeed the outcome) and worry about tomorrow tomorrow. Plus, there is always the opportunity to bring forth new legislation and re-factor the finances down the road. 2) While reasonable assumptions can be made on the cost side of the equation, we can’t reasonably predict how our economy will grow over the next 10 years, and that will have a significant factor on our ability to absorb these costs, should they apply. If there is strong growth, they may just be a manageable burden. Or, for example if Europe falls into prolonged recession coupled with Chinese economic slowdown (and subsequent reduced growth opportunities for American firms), then those costs could feel more like an anchor. 3) The anticipated outcome of an event is typically less extraordinary than the actual result. In that spirit, I don’t know if we’ve ever fallen off of a cliff. Even during the great depression, 70′s stagflation, or the recent housing crisis and subsequent recession – heck even when gas went above $3.00 and almost to $4.00 national average – there has always been a tomorrow and we somehow seem to weather the worst of it. Not that I’m wishing we fall into crisis or anything, just that the human animal is adaptable. Of course, there is always the chance for total collapse, and if nothing else that should keep us on our toes. 4) Lastly, I think the possibility that Washington fails to take care of business and ends up falling into gridlock could provoke a highly volatile response from the general public that could be a game changer for either party, especially whichever one comes out looking worse, and would therefore likely want to be avoided by either side. Plus, with the right’s new found message of “Mitt can get the job done… we don’t fail”, pushing the anti-Obama obstructionist route may no longer go over so well, even within their own party. Were I a betting man, I would say that we get a deal done to avoid a short term crisis, but probably at close to the last minute (or at least last day) with plenty of finger pointing and accusations to go around during the process. 5) Long term, both sides need to continue to work with each other so we are not just in the business of scrambling at the last minute to avoid potential doom, but rather working together to bring forth proactive legislation that builds. That was once upon a time in Washington, maybe it can be again.
I think it can be. Sadly, I don’t think it will be anytime in the near future. Maybe a few more election cycles… But by then I fear we could have massive amounts of debt and put forth massive cuts to entitlements, which would cause utter outrage.
I’m a bit fatalistic in that I don’t think anything is really going to be done about it. Sure, a bill or two might be passed, and all of Congress will pat themselves on the back and give some talks about how they “came together to help save America”, or something equally nauseating, but at the end of the day we are still fiscally screwed. If the market were allowed to clear in 2008, we might still have a chance, but with the advent of Too Big to Fail, a dangerous precedent has been set and the trend seems to be more interventionism in the economy. Therefore, if we do have another recession, and I personally have no reason to think we won’t, we will once again bail out the banks and any other large firms that are deemed too important to fail (which, by the way, is really just back door corporatism).
The problem isn’t simply our national debt; it’s personal debt as well. Practically everybody is struggling with overwhelming debt, and our national debt is simply a reflection of that. The only way out of a massive debt problem is liquidation of the debt, massive increase in liquidity into the market, or outright jubilee. Since debt wasn’t allowed to liquidate, and a jubilee would possibly not be popular (in addition to being inflationary), we can probably expect the Fed to keep printing enough to keep debt serviceable, but not enough to actually clear the debt, because that would be very inflationary as well. Japan has been stuck in a similar situation beginning in the 90′s, and they’re still stuck in it.
And this isn’t even getting at the socio-political upheaval that a poor economy seems to bring about. Personally, I think we’re in for a rough road ahead.
As do I =\
I don’t know much about the other economies in the world yet, but I do remember my father telling me that Japan has been stuck in a similar place for almost 20 years. He’s a portfolio manager, a very skilled one, and he’s not exactly happy with what he’s seeing with the stock market right now. He also thinks we’re about to hit a rough patch. He just doesn’t know when exactly.
Very good post and comments. Well done all. I found of interest Jeb Bush’s comments of two months ago as he was lamenting the demise of the GOP to what it has become. He said the deal brokered by Speaker Boehner and President Obama last summer which had $10 expense cuts per $1 revenue increase was as close to a “no-brainer” that could have been created for the GOP. Yet, Boehner could not get his extremists to buy it thanks to Grover Norquist holding people hostage. So, this commission of six from each party was set up destined to fail which put this cliff in motion. Until we put revenue increases on the table with expense cuts, the math will simply not work. And, as noted by the Paris based Organization for Economic Cooperation and Development, we are one of the least taxed countries in the world (32nd out of 34 countries). I advocate the Simpson-Bowles plan for 2014 with some version of the extension of the FICA payroll tax and Bush tax cuts for one more year only. At some point, we need to step up and pay for something. Well done.
[...] I’m not going to go into all the detail of the fiscal cliff, you can read a nice summary here. In a quick nutshell, the fiscal cliff can be summarized with this quote: “The looming [...]