Peering Over Cliff: $536 Bil Tax Hike On U.S. Economy

December 27, 2012

Even for those who aren't afraid of heights, peering over the fiscal cliff may be dizzying. The plunge in after-tax income that would occur in a worst-case scenario likely would put the economy back in a deep recession.

Yet a peek over the edge now seems unavoidable, at least according to Senate Majority Leader Harry Reid: "It looks like that's where we're headed," Reid said in a Senate floor speech on Thursday.

So here's what the view looks like. The fiscal cliff is composed of $536 billion in 2013 tax hikes, the Tax Policy Center says.

The biggest tax hikes would be an end to President Bush's 2001 and 2003 income and investment tax cuts and President Obama's 2 percentage point payroll tax cut.

But that's just the beginning. Nearly 90% of households would face an average tax increase close to $3,500.

The fiscal cliff also would trigger roughly $115 billion in automatic spending cuts.

Dancing On The Edge

The Congressional Budget Office, generally too optimistic, says the jobless rate would go back up to 9.1%, and the economy would contract at a 2.9% rate in the first half of 2013.

That outcome is hard to imagine because no one wants it to happen. The havoc that a full-fledged cliff dive would wreak might even trigger a credit rating downgrade, Moody's has said.

But the cliff analogy is somewhat misleading, so politicians seem willing to dance on the edge. Rather than plunging on Jan. 1, the economy would likely downshift gradually and only begin to lose altitude if the standoff extends into weeks.

More likely, some compromise will be found early in 2013 to avoid an outright plunge, but not necessarily a pretty big bump. The longer negotiations drag on, the more urgent a deal will become and the more likely it is that some economically hurtful tax hikes will slip through.

In return for getting a tax hike on high earners, the White House has signaled that it's willing to let the payroll tax cut expire too.

Big, Broad Tax Hikes Loom

Under the tax hikes in the fiscal cliff backed by Obama, the top effective federal marginal tax rate on work income would rise to about 44.6% from 37.9% in 2012.

That includes a hike in the top income-tax rate to 39.6% from 35%; an increase in the Medicare tax on earned income to 3.8% from 2.9%, which passed with ObamaCare; and the return of 2001 deduction limits amounting to a 1.2 percentage point marginal rate hike.

In addition, the top effective capital-gains tax rate would go to 25% from 15% (including ObamaCare's 3.8% tax on investment income as well as deduction limits).

The top effective tax rate on dividends would spike from 15% to 44.6%, in line with the top rate on regular income.

Ending the Bush upper-income tax and investment tax cuts would mean a $52 billion hike in 2013, the Tax Policy Center says.

Ending the Bush middle-class tax cuts would raise $171 billion.

New ObamaCare tax hikes would raise $24 billion in 2013.

The alternative minimum tax would snare an extra $40 billion, if not updated for inflation.

Ending the payroll tax holiday would raise $115 billion.

Phasing out expanded earned income, child and tuition tax credits from the 2009 stimulus would raise $27 billion.

Returning the estate tax to 2001 parameters — a 55% rate and $1 million exemption — would raise $31 billion.

A host of regularly extended targeted tax credits, many for business such as the R&D credit, would raise $75 billion.

Automatic spending cuts include defense (about $32 billion); nondefense discretionary programs and Medicare physician reimbursements ($53 billion); and jobless benefits ($30 billion).