Toppling off the fiscal cliff: Tax increases for all
By Roberton Williams, Eric Toder,
Donald Marron, and Hang Nguyen
Urban Institute and
Urban-Brookings Tax Policy Center
www.taxpolicycenter.org
The United States is fast approaching what many observers call the “fiscal cliff.”
If the president and Congress do not act, taxes would jump for most Americans and government spending would drop sharply. Those changes would reduce the federal deficit significantly in 2013 and subsequent years, slowing America's build-up of debt and reducing debt as a share of gross domestic product.
But the resulting macroeconomic tightening could well push the country back into recession in 2013.
Lawmakers could soften that near-term hit by delaying or repealing provisions in the "cliff" or by enacting other spending and tax policies that would provide offsetting support for the economy.
To provide context for these policy discussions, this report provides a detailed look at the pending tax increases and documents their potential effects on federal revenue, the distribution of the tax burden, and economic incentives.
Our findings are as follows:
• Absent legislative action, most tax cuts enacted since 2001 will expire on January 1, 2013, raising tax rates, reducing deductions and credits, and throwing millions of taxpayers onto the alternative minimum tax (AMT). The estate tax would hit more than ten times as many estates as in 2012. The 2 percentage point cut in the payroll tax rate would lapse, raising taxes on more than 120 million households with workers.2 Short-term tax breaks that Congress regularly renews, some of which have already lapsed, would disappear, boosting taxes for both individuals and businesses. And the 2010 healthcare legislation would impose new taxes on high-income taxpayers.
• Federal tax collections would jump by more than $500 billion in 2013, more than 20 percent above what they would be without the cliff. Nearly 90 percent of all households would face tax increases averaging nearly $3,500. Middle-income taxpayers would see an average increase of almost $2,000.
• For both policy and political reasons, it is important to distinguish among distinct aspects of the fiscal cliff.
The expiring cut in Social Security taxes was always intended as a temporary stimulus measure. Policy debate has thus been about when it would expire, not whether.
In contrast, most policymakers favor extending the higher exemption for the alternative minimum tax (the “patch,” which expired at the end of 2011) and most of the 2001/2003 tax cuts (all except those that apply to taxpayers whose incomes fall above the thresholds that President Obama has used to identify high-income taxpayers—$250,000 for married couples and $200,000 for others).
Policymakers generally agree on the need to address the estate tax and the extenders (a diverse group of temporary tax breaks, mostly business but some individual), but they differ on specifics.
1. The spending cuts in the fiscal cliff include the across-the-board sequesters required by the Budget Control Act of 2011, expiration of extended unemployment insurance benefits, and reduced physician payment rates in Medicare (Congressional Budget Office 2012a, 2012b).
2. This analysis examines the effects of scheduled tax changes on tax units—individuals or couples who either file tax returns or would do so if they had enough income. Tax units are not exactly the same as households, but the two terms are used interchangeably in this discussion for expositional simplicity.
The most disputed provisions in the cliff are the expiring tax cuts for high-income households and the expiring 2009 tax credit expansions that primarily benefit low-income households. The new taxes created by 2010’s health reform legislation are also controversial as part of the broader disagreement about that law.
• The components of the fiscal cliff have different effects on households at different income levels.
For most households, the two biggest increases would be the expiration of the temporary cut in Social Security taxes and the expiration of the 2001/2003 tax cuts.
Households with low incomes would be particularly affected by the expiration of the credits expanded or created by the 2009 stimulus.
Households at the highest income levels would be particularly affected by expiration of the 2001/2003 tax cuts that apply to upper income levels and by the new health reform taxes.
Upper middle-income households would be particularly affected by the expiration of the AMT patch.
In addition to raising average tax rates, the fiscal cliff would substantially raise marginal tax rates, which can have an important impact on taxpayer behavior.
The average marginal tax rate would increase by about 5 percentage points on wages and salaries, by about 5 percentage points on interest income, by about 7 percentage points on long-term capital gains, and by more than 20 percentage points on qualified dividends.
If investors believe it will actually happen, the pending increase in the capital gains tax rate could induce them to sell appreciated stocks, bonds, and other assets before the end of 2012.
That would create a temporary spike in realizations, much as happened in 1986.
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Impending Tax Increases
Federal taxes are scheduled to rise in 2013 for six reasons.
First, most of the Bush-era tax cuts that were enacted in 2001 and 2003 and extended for an additional two years at the end of 2010 are again set to disappear.
Second, some of the temporary tax cuts that were part of the American Recovery and Reinvestment Act of 2009 (ARRA) and also extended at the end of 2010 will expire.
Third, Congress has not acted on dozens of short-term tax breaks that are regularly extended.
Fourth, the payroll tax cut, always intended to be temporary, is set to expire after a two-year run.
Fifth, new taxes enacted in 2010’s Affordable Care Act (ACA) will take effect in tax year 2013.
Finally, the AMT “patch” that protects tens of millions of taxpayers from additional taxes expired at the end of 2011. Unless Congress extends the patch retroactively, many taxpayers will owe AMT on their 2012 tax returns (the tax returns that people will file in early 2013).
For the full report, go to: www.taxpolicycenter.org/UploadedPDF/412666-toppling-off-the-fiscal-cliff.pdf