Spotlight on Economics: The fiscal cliff and taxmageddon

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Two months ago, the International Monetary Fund (IMF) issued its outlook for the world economy during 2013. The IMF identified two major obstacles to worldwide economic growth: The U.S. “fiscal cliff” and sovereign debt problems in the Eurozone (See “Spotlight on Economics,” April 11, 2012, here

Some writers have used the term “fiscal cliff” to refer to the increase in taxes (approximately $500 billion annually) and decrease in government outlays (approximately $100 billion annually) that are scheduled to begin on Jan. 1, 2013. Because most of the scheduled changes in fiscal policy result from higher taxes, some writers term it “taxmageddon.”

Specifically, the 2 percent payroll tax cut and the alternative minimum tax (AMT) patch will expire. There will be increases in marginal tax rates and tax rates on qualified dividends and long-term capital gains. There also will be a larger marriage penalty, a reduction in exemptions for estate taxes and new taxes imposed by the 2010 Patient Protection and Affordable Care Act (Obamacare).

The fiscal cliff arises because Congress and the president often have enacted legislation that temporarily changed fiscal policies rather than enact legislation that would fix the long-term budget and national debt problems permanently. Examples include legislation enacted in December 2010, August 2011 (controversy regarding raising the ceiling on national debt) and December 2011.

The threat of the fiscal cliff already has increased uncertainty, so some businesses have postponed investment decisions to buy new equipment and buildings, thereby significantly contributing to the slow growth of real gross domestic product during the second and third quarters of 2012.

The Congressional Budget Office predicts unemployment will increase and the U.S. will fall into another recession unless Congress and the president enact legislation to prevent the fiscal cliff.

The immediate negative impact on aggregate demand mostly will come from the expiration of the reduced payroll taxes and the approximate 30 million taxpayers who will pay higher 2012 federal income taxes because they will be subject to the AMT. Indeed, the Internal Revenue Service (IRS) has stated that without the AMT patch, it will have to delay tax refunds. In addition, the long-term unemployed will lose the temporary extension of their unemployment benefits.

Other economists are less pessimistic because they see more of a slope than a cliff because not all changes will affect spending immediately. Many tax increases will affect taxes owed at the end of 2013, thus the economic impact may depend on how quickly the IRS changes tax withholding.

Most likely Congress and the president once again will enact a temporary fix rather than deal with the nation’s long-term fiscal problems, which would require a comprehensive reform of the tax system and entitlement programs.



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