ECON 101: Fiscal Cliff: The Not So Big Deal
Subscribe today for Free Enterprise Updates
- Latest business trends and best practices
- News about legislation and regulation impacting business
- Business how-to articles from industry experts
- Commentary and interviews with newsmakers in business and politics
For most, as midnight approached on New Year’s Eve 2012, revelry ensued and confetti dropped. In Washington, the tone was more somber as Congress worked to avert going over the fiscal cliff. Shortly after 2 a.m. on January 1, the Senate, by a vote of 89-8, passed legislation that addressed certain tax aspects of the cliff but kicked the can on the sequester, effectively shutting it off for two months. After some foot dragging, threatening amendments, and slight rebelling in the Republican House caucus, on New Year’s Day, around 11 p.m., the House also approved that bill by a vote of 257-167.
This legislation, technically referred to as The American Tax Relief Act of 2012, is pretty much as expected. It hardly comes as a surprise that legislation done in a lame duck session is, well, lame. Let’s take a look at what did and did not make it into this “not so big” deal.
This legislation made permanent several provisions of tax law. It’s important to note that “permanent” simply really means “extended indefinitely,” as any Congress, current or future, is always able to make changes to the tax code. That said, the legislation “permanently” extends current marginal tax rates for those making up to $400,000 (single) or $450,000 (married). For those successful small businesses making over those amounts, marginal rates rise to Clinton-era levels, with rates going as high as 39.6%.
With regard to capital gains and dividends, once again, those making under the $400,000/$450,000 threshold will see a 15% rate extended indefinitely. However, those making over those amounts will see their rates on investment income permanently rise to 20%. Further, thanks to health care legislation enacted in 2010, anyone making over $200,000 (single) or $250,000 (married) will pay an additional 3.8% surtax on investment income starting this year. So, for some, investment taxes rise as high as 23.8%.
This legislation also made permanent an estate tax with a $5 million per spouse exemption level, indexed for inflation, but increased the rate from its current level of 35% to 40%.
Congress also permanently reinstated PEP (personal exemption phaseout) and Pease (limit on itemized deductions) for those making $250,000 (single) and $300,000 (married), thus reducing for taxpayers making over those amounts deductions for things such as mortgage interest, charitable giving, and state and local taxes paid.
The legislation indefinitely indexes the alternative minimum tax (AMT) for inflation, thereby eliminating the need for Congress to “patch” the AMT each year.
The legislation also includes some temporary extensions of expired items. It provides a one-year extension of bonus depreciation through the end of 2013. It also extends certain expired and expiring provisions, such as the research and development (R&D) tax credit, the deduction for state and local sales tax, and the active financing exception for two years, retroactively for 2012 and through the end of 2013.
Also included in the legislation is a temporary one-year extension of the doc fix, which heads off large cuts in reimbursements to Medicare providers, as well as a one-year extension of unemployment insurance.
What’s Not In
So what didn’t make the cut? The temporary payroll tax cut, which had been in effect for the prior two years and had reduced workers’ share of the Social Security payroll tax by two percentage points to 4.2% from 6.2%, was allowed to expire. Further, the legislation includes no cap on deductions, an idea that President Obama had floated in his previous budgets and that Gov. Romney had once supported during his presidential campaign.
Perhaps, more importantly, are the big items that didn’t get addressed. Despite an announcement by Treasury Secretary Tim Geithner on New Year’s Eve that we had hit the $16.4 trillion debt ceiling, Congress did not raise the limit. The secretary, instead, will use extraordinary measures to avoid default on our debt for about two months. And despite a two-month “kick the can” approach to the sequestration, there was no real solution proposed to replace those spending cuts, which were never intended to go into effect and were reviled by both sides of the aisle. Combine these two events with the need to do another continuing resolution (CR) to fund the government and avert a shutdown, and we have the first in a series of mini-cliffs to look forward to in a few short weeks.
What else didn’t we get? We didn’t get comprehensive tax reform. That comes as no surprise, as tax reform isn’t generally an item that can be accomplished in a lame duck session of Congress, nor should it be. However, we got no mechanism or assurance that Congress would undertake the comprehensive tax reform so desperately needed to lower tax rates for all businesses, shift to a territorial tax system to make American worldwide companies more competitive, and bring certainty to businesses.
We also didn’t get any real plan to address excessive government spending or reform our unsustainable entitlement programs. And once again, while no one really expected sweeping entitlement reform in a lame-duck session of Congress, this legislation made no steps and provided no path forward on these issues.
In addition, while we did get an extension of unemployment insurance, giving some workers a disincentive to look for work, we got no policies or plans to drive economic growth and put people back to work.
In sum, what we got was a “not so big” deal. It raises taxes for some taxpayers, but not likely to a level that will do real harm to economic growth. As noted, the law, by not tackling any of the more challenging fiscal issues, sets up a new series of fiscal cliffs for the 113th Congress – the soonest being when the sequester’s two-month delay and debt ceiling extraordinary measures expire and when the CR runs out.
Moreover, this legislation fails on several other fronts as well. It does not put in place measures to stabilize the debt as a share of GDP, let alone reduce it. It does not include any serious entitlement reforms or set up a process for considering reforms, even though rising health costs remain our largest single fiscal challenge and Social Security is on the road to insolvency. Further, it does not include a process to enact pro-growth and revenue-generating comprehensive tax reform.
And since it fails to do all those things, it ultimately fails to get us any closer to controlling our elevated levels of debt and historically large deficits. So while we may have averted some tax hikes, the 112th Congress certainly left plenty for the 113th to do if we are serious about improving our nation’s fiscal health.
Caroline L. Harris, chief tax policy counsel at the U.S. Chamber of Commerce, is the primary author of this article.