The "Fiscal cliff" is the combination of United States financial policy changes that were scheduled to take effect at the start of 2013. The Congressional Budget Office has predicted that if those policies are allowed to take effect, they will place the United States economy into a recession. On February 29, 2012, Ben Bernanke coined the term "fiscal cliff" in his testimony before the House Financial Services Committee.
The policy elements of the fiscal cliff include:
- the expiration of the tax cuts enacted during the George W. Bush Administration.
- the automatic spending cuts (called sequestration) required by the 2011 budget compromise.
- the federal borrowing authority reaching a Congressionally-enacted limit.
- the reversion of the Alternative Minimum Tax thresholds to their 2000 tax year levels;
- the expiration of the 2% Social Security payroll tax cut.
- the expiration of various targeted tax credits designed to encourage economic activity.
- the expiration of the "doc fix", which provided higher reimbursement rates to hospitals and doctors that treat medicare patients.
- the new taxes imposed by the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.
The creation of the fiscal cliff was an unintended combination of events. The "cliff" refers to the large number of policies with economic impacts that are set to expire on December 31, 2012. Although such policies issues are usually addressed in advance of the expiration date, politicians fear angering taxpayers by voting on these items before the November 2012 general election. So, any action on the fiscal cliff issues will occur during the lame duck session between the November 6, 2012 election and the end of the year. The action may be a permanent set of changes or a short-term extension of the 2012 policies into 2013 to avoid or smooth-out the "cliff."
The tax cut legislation enacted in 2002 and 2003 was subject to "pay as you go" Congressional rules that required the cuts to be scored by the Congressional Budget Office over a ten year period. As a result, the legislation provided for only temporary tax cuts that were scheduled to expire at the end of 2010. In a budget compromise, the Republican members of the House of Representatives and President Obama agreed to extend the cuts until the end of 2012 in exchange for extending unemployment insurance benefits.
During the summer of 2011, House Republicans refused to increase the ceiling on the total federal borrowing authority. Although Congress had passed appropriations on the assumption that additional money would be borrowed to meet deficit spending levels, without a higher ceiling, the U.S. Treasury could not borrow the money to pay what the federal government owed to vendors, suppliers, employees or beneficiaries. The United States would default on its debts and be forced to shut down. A compromised (called the Budget Control Act of 2011) was reached that raised the debt ceiling in exchange for the creation of a "Supercommittee" that would find spending cuts to take effect in 2013, with other spending cuts going into effect immediately. If the Supercommittee could not reach an agreement or if Congress rejected their recommendations, then automatic across-the-board cuts to both defense and domestic spending would take place. The law was drafted to make the automatic cuts so undesirable that Congress would be forced to work out a deficit reduction agreement. However, the Supercommittee failed to agree and both Republicans and Democrats decided in 2011 to leave the spending cut question for additional legislation in 2012. If a new law was not passed before December 31, 2012, then automatic spending cuts under the existing law would apply to almost all federal programs in 2013.
Although the 2011 agreement raised the federal borrowing ceiling, the federal debt has continued to grow and the new ceiling is expected to be reached in early 2013.
In 2009, Congress enacted a stimulus bill that included a Making Work Pay tax credit that expired at the end of 2010. The 2010 budget agreement replaced that tax credit with a two-year temporary 2% reduction in the Social Security payroll tax. Instead of individual workers paying those taxes into the Social Security Trust Fund, Congress moved money from the general fund to replace those dollars. This added about $1,000 per year to the average worker's paycheck. Without further action, the Social Security deduction on paychecks increased from 4.2% to 6.2%.
Letting these cuts expire would lead to higher taxes for every tax group.
|“||The existing 10% bracket will go away, and the lowest "new" bracket will be 15%. The existing 25% bracket will be replaced by the "new" 28% bracket; the existing 28% bracket will be replaced by the new 31% bracket; the existing 33% bracket will be replaced by the 36% bracket; and the existing 35% bracket will be replaced by the 39.6% bracket.||”|
Capital gains will increase to 20% from 15%, the maximum tax rate on dividends will skyrocket to 39.6%.  Joint-filer (Marriage penalty) tax brackets will return to 167% of the amount for singles, causing higher tax bills for many low and middle income Americans. Phase-Out Rule for itemized deductions could eliminate up to 80% of higher-income bracket deductions for mortgage interest, state and local taxes, and charitable donations. Phase-Out Rule for personal exemptions could eliminate some higher-income bracket personal exemption deductions (typically average $3,800.).
President Obama proposed to extend the Bush tax cuts for all taxpayers on just the first $250,000 of annual income. On July 25, 2012 the U.S. Senate voted 51-48 to pass a bill supporting the President's tax proposal, while rejecting the Republican proposal of extending the tax cuts for all 45-54. The U.S. House of Representatives rejected, 170-257, the President's tax proposal on August 1, 2012.
Although President Obama asked Congress to remove the Bush tax cuts for the middle class from the debate, the failure of the House to accept his plan and the failure of the Senate to extend all Bush tax cuts implies that the cuts will be allowed to expire as provided in existing law. Congress will then claim that they are not raising taxes, but just failing to vote to lower them.
Congressional Republicans have proposed that the Bush tax cuts be extended in their entirety. Republicans have also proposed that the sequester for defense funding be repealled while leaving the sequester of domestic spending in place.
A bipartisan group of Senators, called the "gang of eight", is discussing ways to avoid or smooth out the fiscal cliff. One of the eight, Mark Warner of Virginia, drew controversy by sending out an email invitation to a fundraiser based on this work. The email invited lobbyists to donate $1,000 to $5,000 for a chance to discuss the fiscal cliff with Warner. "Instead of kicking the can down the road, Senator Warner is back in action with the Gang of Eight — originally the Gang of Six — to address the debt and deficit with a long term solution," the fundraising email read. "This bipartisan team is gearing-up over lame duck to reintroduce a deficit reduction plan that looks like Simpson Bowls 3.0; an updated version of the commission to reform a tax code that produces too little and entitlement programs that spend too much." Ninety minutes later, the event was cancelled by a second email.
On October 18, 2012, fifteen of the largest US financial companies warned President Obama that interest rates could spike if new laws did not avoid the fiscal cliff. A group called "Fix the Debt" is planning to spend $30 million to pressure Congress to act to avoid the cliff. Scott Mather, head of global portfolio management for Pimco said, "The U.S. will get downgraded, it's a question of when."
The AARP is opposing any further extension of the Social Security payroll tax rate reduction. AARP fears that if the Social Security Trust Fund comes from general funds, Congress will be more likely to want to cut future benefits.
Although the basic elements of the 2013 federal spending levels, federal debt ceiling, and possible tax reform remain unaddressed, a new American Taxpayer Relief Act of 2012 was passed by the Senate 89-8 and by the House 257-167 on January 1, 2013 with President Obama signing it on January 2, 2012. In brief, the law:
- delays sequestration by two months
- adopts permanent reduction of income tax rates for 98% of taxpayers
- allows the 2% payroll tax reduction to expire
- adopts a permanent fix to the Alternative Minimum Tax
- adopts a permanent "doc fix" adjustment to the reimbursement to doctors under medicare
- allows taxpayers to convert 401(k) retirement plan balances to Roth 401(k) plans (thereby accelerating the payment of taxes)
On January 4, 2013, the CBO issued a summary of the impact of the law. It found a $3.9 billion increase in the deficit over 2013-2022 compared with the existing law allowing the economy to "go over the cliff." However, it projected a -0.5% immediate GNP hit on the economy under the existing law compared with a 1.5% to 1.75% GNP growth under the new law in 2013. Over the long term, the CBO projects that under the new law, GNP "would be 1.7 percent lower in 2022 than would have been the case under prior law."
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