Though the election is long over, the debate over whether or not to extend the Bush-era tax cuts continues.
This is the so-called “fiscal cliff” that’s all over the media right now.
On the surface, this sometimes seems like a debate over taxes in general, and specifically on higher taxes for the rich.
But don’t bet on it – the fiscal cliff doesn’t just affect the rich – it has the middle class squarely in its crosshairs.
A series of tax increases will begin on January 1, 2013, if Congress does not take action to restore at least some of the Bush-era cuts.
And they’ll be substantial.
Not only will the tax cuts reach deep into the wallets of everyone who has a paycheck, but the fallout from the changes will have wide effects on the overall ecomomy too.
How the Fiscal Cliff Will Affect More Than the Rich
The payroll tax cut
The most damaging tax increase for all wage earners will be the expiration of the payroll tax cut.
In order to stimulate the economy in the depths of the recession, Congress created a temporary reduction in the employee portion of the FICA tax. This lowered the tax from 7.65% of earned income to 5.65%, or more specifically on the Social Security portion, from 6.2% to 4.2%.
This translates to a 2% tax increase for all wage earners with an income of up to $113,700 in 2013.
That means that if you’re earning $25,000 per year, your payroll tax will increase by $500. If you are earning $50,000, the result will be a $1,000 tax increase. At $100,000, you will see a $2,000 tax increase.
That will be an automatic tax increase for people in income brackets that could hardly be considered rich.
For many, $500 or $1,000 or a year isn’t much but for others with extremely tight budgets this increase will be sorely felt. This particular tax cut doesn’t have a lot of chance at being extended though since it was always meant to be temporary.
Capital gains tax
The capital gains tax is often framed as a tax on the wealthy.
And while it may disproportionately benefit the wealthy, there are many millions of middle-class households that benefit from the tax break. This usually happens as a result of long-term capital gains that are provided by mutual funds and exchange traded funds.
In 2012, the capital gains tax rate was set at zero for taxpayers in the 10% or 15% income tax brackets. If the Bush-era tax cuts expire that rate will increase to 10%.
For those in the 28% or higher tax brackets, the maximum capital gains rate is 15%. If the Bush-era tax cuts expire that rate will increase to 20%.
Not only will this result in a higher tax bite on long-term capital gains, but it could also create a disincentive to invest in the stock market in general.
The Child Tax Credit
Couples filing jointly and making under $110,000 are currently eligible to claim $1,000 per child (it phases out above $110,000). As it stands, in 2013 the tax credit will reduce to $500. For a family with two children that’s $1,000 they lose out on.
A Change in Tax Brackets
Those in the 10% tax bracket would now see themselves in the 15% bracket. Other bracket would be affected as well but consider this: the upper limit for couples filing jointly is $17,400, which may not seem like a lot but imagine if that is your family income. That additional 5% tax will certainly sting. But here’s another consideration – How many of those in that bracket will find other means of work where they won’t have to worry about the tax, like finding cash jobs off-the-books? Then they don’t pay tax and the government doesn’t collect on any of it.
The Alternative Minimum Tax
Of even greater concern is the effect of the tax cut expiration on the Alternative Minimum Tax (AMT).
This is a tax that is not well understood by most taxpayers, but without a resolution on the fiscal cliff, it will reach down and affect more taxpayers than ever.
Congress has not approved the “inflation patch” that will keep millions of households from being subject to the AMT. If you have an income of over $75,000 and a high level of deductions – including dependents – you could be subject to the AMT for the first time.
It has been estimated that more than 26 million households are about to be subject to the AMT in 2013. The increased tax liability as a result, is estimated to add $3,700 to the average taxpayer’s bill.
A weaker economy
If tens of millions of households are subject to additional taxes of several thousand dollars each, they will have less money to spend and less money to invest.
The effects on the economy could be disastrous. It’s been speculated that a second recession is in store for us if we fly off the “cliff.”
The combination of higher long-term capital gains taxes on top of less disposable income will leave less money to invest. But it could also lead to the liquidation of stock positions as people to raise cash in order to pay for basic living expenses. None of that is good for the stock market.
It should go without saying that consumers with less money to spend will be bad for the economy. Retail sales could decline sharply, as would car sales. But even worse will be the effect it will have on the already weak housing market. All of this would also hurt the stock market.
Though the employment picture has been improving the past couple of years, it’s still a good bit weaker than it has been at the same point in previous recoveries.
The fiscal cliff could undo all of the gains in employment so far.
If people have less money to spend, they won’t be buying the products and services that will be keeping everyone employed. A questionable stock market will only make the situation worse as large companies will have less capital to invest in future expansion.
On the Other Hand
For sure you can see how the “fiscal cliff” will affect more than just those wealthy taxpayers in the upper brackets. This “fiscal cliff” will affect all brackets and it could really hurt those in the lowest brackets.
But let’s face it, our country just isn’t covering its spending!
According to factcheck.org, as a percentage of the country’s economy the Federal government spends 22.7% versus collecting 15.7% in revenues. Running a deficit like that doesn’t help our economy. We need to take action to narrow those numbers.
Letting the tax cuts expire would hurt in the short-term (read: recession) but long run it would help the country reduce its deficit and strengthen the economy. We’d also adjust to the new (old) taxes over time. And after all, the Bush tax-cuts are relatively new. We managed for some time with higher tax brackets and less tax credits.
Maybe it’s time we pull the band-aid off quick and let our economy heal already instead of putting fresh band-aids on it hoping it will magically get better later on?
Of course part of the equation needs to be reducing our spending as well.
The fiscal cliff is more than just a hot term the media is floating around for ratings.
If Congress doesn’t act decisively, this situation can potentially get bad. It could lead to an economy, a job market, a stock market and a housing market that leads us back to the economic uncertainty we felt in 2008, which we’re still recovering from.
At the same time our deficit is growing daily. We borrow money just to pay off the interest on our debt. If I did that people would say my finances were horrible.
Cutting spending is necessary but only goes so far. We need tax changes to increase our revenue. But at the same time it shouldn’t be a drastic change that hurts those already struggling in this economy.
You have the opportunity to speak your mind on this. Contact your Representative and let them know how you feel. The House of Representatives has a handy page where you enter your zip code to find your Rep. (http://www.house.gov/representatives/find/) Email them and speak your mind!
These are your taxes and they will affect your household.