The FAQs: The Fiscal Cliff
Note: The FAQs is a TGCs series in which we answer your questions about the latest news and current events.
What is the "fiscal cliff"?
The recent use of "fiscal cliff", which is believed to have originated in Congressional testimony by Federal Reserve Chairman Ben Bernanke, refers to the substantial changes to tax and spending policies that are scheduled to automatically take effect in January 2013. The changes are intended to significantly reduce the federal budget deficit.
What are the tax and spending policies that will change?
Several major tax provisions are set to expire at year's end:
The 2001/2003 Bush tax cuts: Although these tax cuts were scheduled to end in 2010, they were extended for two years because of the negative effect letting them expire would have on the economy. Currently the individual marginal income tax rates are 10, 15, 28, 33, and 35 percent. In January they are scheduled to revert to 15, 25, 28, 36, and 39.6 percent. The capital gains rate will also increase to 20% and dividends will be taxed at ordinary income rates.
American Recovery and Reinvestment Act of 2009: This "stimulus" act included several tax changes, including an expansion of the higher education credit, earned income tax credit, homebuyer credit, home energy credit, and child tax credit. Each of these would revert back to their pre-2009 levels. For example, the child tax credit would be reduced from $1,000 to $500 per child.
Payroll tax holiday: In 2010, Congress passed a "payroll tax holiday" to help offset the income lost due to high unemployment. The payroll tax rate shifted from 6.2 percent to 4.2 percent in 2011 and 2012, allowing someone making the median income of about $50,000 to save $1,000 a year in taxes.
Alternative Minimum Tax: Each year a taxpayer must pay the greater of an Alternative Minimum Tax (AMT) or regular tax. Since 2003 Congress has passed one-year "patches" to the AMT, aimed at minimizing the impact of the tax. However, because the AMT is not indexed for inflation, it would lead to an increase for middle-class taxpayers.
Additionally, a number of automatic spending cuts would take effect. For instance, the Budget Control Act of 2011 (i.e., the debt ceiling compromise) institutes a 2 percent cut in physician and other providers' Medicare payments, and a 7.6 to 9.6 percent across the board cut in all discretionary spending, except programs for low-income Americans. The cuts are evenly divided between defense and nondefense programs. The act also sets a firm limit on discretionary spending within which policymakers must operate.
What effect would the policy changes have on the economy?
If all these changes take place, the mostly likely effect will be that the economy will slide back into a recession. According to the Congressional Budget Office, if all of that fiscal tightening occurs, inflation-adjusted gross domestic product (GDP) will drop by 0.5 percent in 2013---reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year. That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013.
But when the recession would occur is a matter of dispute. Some economists believe that if the financial markets react negatively the recession could occur as soon as the first quarter of 2013. Others believe the impact would only be felt later in the year.
How will individual taxpayers be affected?
The Heritage Foundation estimates that if we go over the fiscal cliff, the average American will see their tax bill rise by over $4,100 in 2013.
What are the plans for dealing with it?
To date, four main approaches have been proposed:
The Democrats' Plan
Treasury Secretary Timothy Geithner offered the White House's fiscal cliff proposal to Republicans in the last week of November. Although the proposal wasn't released to the public, news reports say it was basically a reprise of President Obama's most recent budget request and contained the following items:
• End the Bush tax cuts for those making more than $250,000. The result would be $1.6 trillion in new taxes over 10 years, $160 billion a year.
• Cuts to Medicare and other entitlements over 10 years equal to $400 million, or $40 million a year.
• Additional stimulus spending of $50 billion.
• Authority to allow President Obama to to raise the debt limit without asking Congress in order to prevent "fiscal cliff"-style triggers from being put in place in the future.
• The White House also counts "savings from ending the wars in Iraq and Afghanistan" in their savings tally, even though no one has proposed maintaining war spending over the next decade at the current rate.
Reception: The Republicans rejected President Obama's plan but offered to let it be voted on in the Senate. However, yesterday Senate Majority Leader Harry Reid (D-Nev.) blocked a vote on the president's proposal.
The Republicans' Plan
Earlier this week, House Speaker John A. Boehner (R-Ohio) and other senior Republicans suggested that a framework laid out by Democrat Erskine Bowles be used as the basis of a plan:
•Raise $800 billion ($80 billion a year) in tax revenue by removing specific existing deductions from the tax code.
•Cutting $600 billion ($60 billion a year) from federal health programs, in part by increasing the Medicare eligibility age from 65 to 67.
•Cutting federal agency budgets by $300 billion over ten years ($30 billion a year).
•Saving $200 billion ($20 billion a year) by applying a less generous measure of inflation to all federal programs, including Social Security benefits, which would slow the growth of those programs.
Reception: President Obama refuses to negotiate on this plan unless Republicans agree to accept income tax hikes on those making $250,000 or more a year.
The Republican Doomsday Plan
Recognizing that they are unable to come to an agreement with the president, some House Republicans are considering a Doomsday Plan:
•Allow a vote on extending the Bush middle class tax cuts (the bill passed in August by the Senate).
•To express disapproval at the failure to extend all tax cuts, Republicans would vote "present" on the bill, allowing it to pass entirely on Democratic votes.
Reception: President Obama has said he will reject this option too, implying that he would veto such legislation.
The 'Let's Go Off the Cliff' Plan
The simplest---and increasingly most likely---option would be for Congress and the White House to take no legislative action before January. The tax increases and spending cuts would occur automatically, forcing Congress to address the issue later in the year.
Why should Christians be concerned?
There are a number of issues related to the fiscal cliff that should be of special concern to Christians:
Reduction in contributions to charities and ministries
Both sides have mentioned a possible middle-ground solution of capping the amount of income that people who itemize their taxes can claim as a deduction for charitable giving. But a nationwide poll conducted by the United Way Worldwide from November 9-20, 2012 shows that almost one-third of Americans would reduce their current giving levels if the charitable contribution deduction were eliminated.
"Federal, state and local government programs are being cut, and charities are being asked to do more to sustain our society. Charities and their donors should not be targeted as a source of government revenue," said Steve Taylor, United Way Worldwide Senior Vice President for Public Policy. "Limitation of the charitable tax deduction will impact those at the bottom of the economic spectrum."
The adoption tax credit could expire
According to Baptist Press, many in the adoption community are concerned the adoption tax credit set to expire at year's end could be forgotten. The tax credit that provided last year a maximum of $13,360 to each adoptive family has helped countless low- and middle-income families afford the costly endeavor. Unlike a tax deduction, which only reduces taxable income, a tax credit actually reduces a person's tax liability.
"To be sure, we should help each other find and keep work. We should care about the larger problem of unemployment," says John Piper in Don't Waste Your Life. "It is not first an economic problem, though it is that. It is first a theological problem. Human beings are created in the image of God and are endowed with traits of their Creator that fit them for creative, useful, joyful, God-exalting work. Therefore, extensive idleness (when you have the ability to work) brings down the oppression of guilt and futility."
Other Posts in this Series: