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Infographic: What is the 'Fiscal Cliff'?



Several key financial programs put in place over recent years to stimulate our economy are set to expire in the coming months. Combining that with reductions in fiscal support for various federal programs, some fear we may soon face the perfect storm of financial doom - or what some experts are calling the “fiscal cliff.”

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In 2011, a congressional super committee was formed to settle disputes about the debt ceiling, fiscal reform, and other tax measures on which Congress had taken no action. Months later, the super committee would disband among a downgrade in the country’s credit rating, and a lifting of the debt ceiling. As a result, congress was forced to enact deep budgetary cuts in many federal programs starting in 2013.

With all those measures coming to term in January 2013, there is little time to put into motion the groups of people that would need to come together in finding a solution to the impending fiscal cliff, the biggest portion of which, experts believe to be the extension of Bush tax cuts.

Tax cuts are one of the most closely watched political measures because they have the ability to affect so many people. The public largely welcomes them, and have come to rely on tax cuts or credits for income tax, real estate mortgage interest, childcare, and unemployment benefits. Businesses benefit too, with periods of lower payroll taxes.

Table 1. The table below shows the current tax cut system put in place by former President George W. Bush. The second column shows the potential tax rates for those same brackets if the tax cuts are allowed to expire. The third column shows the percent change. As you can see, the largest tax rate increase of 50% would be on the lowest tax bracket. Again, this assumes that ALL tax cuts expire:

 

With Bush Tax Cuts If Bush Tax Cuts Expire Difference*
35% 39.6% +13.1%*
33% 36% + 9.1%
28% 31% + 10.7%
25% 28% + 12%
15% 15%  None
10% 15% +50%

*To compute the percent change in the tax rates, you do not do a simple addition/subtraction. Percent change is calculated as follows:

forumla to compute percent change in tax rates

 

Table 2. To put those tax bracket changes into context, the table below shows the expected marginal tax increase by income level.

Family Income Level Expected Marginal Tax Rate Increase
Less than $10,000 + 64.42%
$10,000 - $20,000 + 26.46%
$20,000 - $30,000 + 5.58%
$30,000 - $40,000 + 2.79%
$40,000 - $50,000 + 2.16%
$50,000 - $75,000 + 7.81%
$75,000 - $100,000 + 16.70%
$100,000 - $200,000 + 8.50%
$200,000 - $500,000 + 6.22%
$500,000 - $1 million + 26.16%
$1 million or more + 16.36%

 

The nonpartisan Tax Policy Center calculates the fiscal cliff will result in higher taxes for 90% of Americans, with an overall tax bill increasing $755 for the average middle-class family. Put simply, higher taxes equal less money in your pocket.

So how can we avoid the fiscal cliff?

There’s little time to act, but there are still options. One possibility is an emergency temporary extension of the status-quo; a short term stop gap that keeps tax cuts in place for another six months to a year while lawmakers come together to overhaul the tax code. But many members of Congress, and financial experts, are weary of such an option, afraid it would serve only to delay the inevitable.

Alternatively, both sides could come together on a bipartisan compromise that everyone can live with. Let's not forget the strong economy of the middle to late 1990s after the standoff between President Bill Clinton and Congress. Perhaps another standoff, with a sharing of ideas, and a willingness to compromise will be the best thing for our economy.