Policy Experts Outline Tax Impact of Fiscal Cliff

If Congress fails to act on expiring tax cuts by the end of 2012, nine out of 10 Americans will see their taxes go up, as average households would see a $3,500 increase. And that is just the beginning, according to the Tax Policy Institute (TPC), which outlined on October 2 the dire consequences of what is often referred to as “taxmageddon.”

Without 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 under the alternative minimum tax (AMT), according to a TPC report. The estate tax would hit more than 10 times as many estates as in 2012. The two-percentage point cut in the payroll tax rate would lapse, raising taxes on more than 120-million households with workers. Short-term tax breaks that Congress regularly renews, some of which have already lapsed, would disappear, boosting taxes for both individuals and businesses. In addition, the 2010 health-care legislation would impose new taxes on high-income taxpayers.

Estimates from the TPC and the Joint Committee on Taxation indicate that, if all the tax increases scheduled for January 1, 2013, take effect, and if the AMT patch is not extended through 2013, tax liability will increase by $536 billion—or about 21 percent—in 2013. 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. The wealthy would be hit hard by the expiration of the 2001/2003 tax cuts that apply at upper income levels and the start of the new health care reform taxes.

Average marginal tax rates would increase by five percentage points on labor income, by seven points on capital gains and by more than 20 points on dividends. 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, according to tax policy experts at the TPC. However, the resulting macroeconomic tightening could well push the country back into recession in 2013, according to a report by the Congressional Budget Office.

The most disputed provisions in the fiscal 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 care reform legislation (the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148 )) are also controversial as part of the broader disagreement about that law. The TPC report ranks the tax increases most likely to occur, starting with the expiring cut in Social Security taxes, or the payroll tax holiday, which was always intended as a temporary stimulus measure. Taxes deriving from provisions in the PPACA are also a given.

All of the estimates, however, are based on Congress’s inaction, and the top taxwriters are actively looking for a solution before the end of 2012. Lawmakers generally agree on the need to address the estate tax and the extenders, but they differ on specifics. Most members of Congress and the Obama administration favor extending the higher exemption for the AMT and most of the 2001/2003 tax cuts, 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.

By Jeff Carlson, CCH News Staff

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Wolters Kluwer Tax and Accounting

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