What Will Happen to Your Taxes in 2013

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Do you feel like a pawn yet?

If you pay income taxes, then Congress has some drama in store for you over the next several months. Your taxes might go up. They might stay the same. They probably won't go down, but a few politicians may promise that they will anyway. Whatever the final outcome is, you probably won't know until the very last second--maybe even later.

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For those who haven't heard, a huge set of decisions needs to be made by the end of the year to deal with "temporary" tax cuts that have been in place for up to a decade, but are due to expire. If Congress does nothing and allows the tax cuts to lapse, income-tax rates for most Americans will rise by three percentage points, and a lot of deductions will shrink.

Congress probably won't sock working Americans with a sharp, overnight tax increase. But profound disagreement between Republicans and Democrats over, well, practically everything augurs an intense fight that could unnerve a lot of taxpayers.

Sen. Patty Murray of Washington, for instance, recently suggested that she and her fellow Democrats should let all the tax cuts expire at the end of 2012, as a tactical ploy to raise taxes on the wealthy but reinstate the lower rates for middle-class earners later on. So for most Americans, it would be a phantom tax hike. Or something like that.

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Nothing will happen till after the November elections, of course, since future tax policy depends on who will control Congress and the White House over the next several years. But here's some handicapping on what's likely to happen, no matter who wins in November:

The Bush-era tax cuts will probably be extended for one year. Allowing them to lapse and imposing massive across-the-board tax hikes would simply be too much of a shock to the economy. It might also generate a taxpayer revolt against Congress, which some legislators would actually like to prevent. One more temporary extension will give the next Congress time to work on a more permanent solution.

But tax hikes might take effect, temporarily. Murray isn't bluffing. Some budget experts think the lame-duck Congress won't be able to reach a deal on the expiring tax cuts, and will postpone the matter until the next Congress is sworn in in late January. "I don't seen any politics that could facilitate a deal in the lame-duck session," says Jared Bernstein of the Center for Budget and Policy Priorities, who served as Vice President Joe Biden's chief economist. "Then within a few weeks, there could be a large tax cut." Tax withholdings would have to be manipulated so that higher rates at the start of the year are offset by lower rates later. But the process could be chaotic, as stock markets tank and everybody waits to see whether Congress can defuse a bomb of its own creation. "It would be pretty freakin' nuts," says Bernstein. "That's no way to run an economy."

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The payroll tax cut might expire. A law passed in 2010 reduced the Social Security tax withheld from most people's paychecks from 6.2 percent to 4.2 percent, up to $110,100 of income in 2012. That, too, is due to expire at the end of this year--and unlike the Bush-era tax cuts, it might. "Congress might let the payroll tax holiday lapse," says Clint Stretch, former managing principal at Deloitte Tax. "That's easier, because it was understood to be temporary." For somebody earning $50,000 a year, a return to the higher rate would cut take-home pay by about $80 per month. Congress might compensate by devising other tax breaks, but ending the payroll-tax cut would appease some lawmakers eager to start reducing Washington's annual deficits.

Longer-term tax hikes are coming. Taxpayers will probably dodge a bullet at the end of 2012, but they should still prepare for tax increases, no matter what politicians say. The national debt is simply too big, and vital programs for seniors and the poor won't be able to survive without additional funding. "It is mathematically impossible to preserve our current path for Medicare, Medicaid, and Social Security without a blistering tax increase on the working age middle class at some point in the near future," says a recent report by Third Way, a centrist think tank.

Wealthier taxpayers could see higher taxes and smaller deductions as part of a deal in 2013, which is basically a condition that Democrats have set for any kind of compromise. From there, pressure will mount to raise other taxes, since the wealthy alone can't possibly cough up enough money to finance even a shrunken government. The year-end tax battle will only be an opening skirmish, with many more to follow.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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