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Kimberly Amadeo

We're Going Over the Cliff — For About a Week

By December 27, 2012

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Today, Senate Majority Leader Harry Reid accused the Republican majority in the House of holding the economy hostage by refusing to vote on President Obama's Plan "A." House Speaker John Boehner retorted that the Senate is refusing to vote on an earlier plan submitted by the House that extends the Bush tax cuts for everyone. Given that there is only three days left in the year, it looks like this stalemate means we are going over the  fiscal cliff.  What does this mean to you?

Already, the stock market is dropping, negating any "Christmas bonus," the uptick in stock prices that usually occurs at the end of the year. Second, two million unemployed already received letters saying they are losing their extended unemployment benefits. Third, the fiscal cliff fiasco has created an opportunity for all the prophets of doom to say, once again, that the government is broken and we are headed for a recession.

However, what is most likely to happen is that, after about a week, the House and the Senate will find a way to restore the Bush tax cuts for those making less than $250,000. Both sides agree this should happen, because the long-term impact of higher tax rates would throw the economy into recession. That's because a total of $229 billion will be removed from consumers' hands, reducing demand.

They will probably agree to work on a combination of a higher tax rate or fewer deductions for incomes above $250,000 a year. Tea Party Republicans could, with good conscience, vote for such a package after January 1. Why? Because it would be a tax cut compared to a rate with no deal.

Both sides also agree there should be spending cuts, although in different programs. They could agree to negotiate the specifics as part of the FY 2014 budget process.

What It Means to You

If you are unemployed, and are losing your benefits, there is a slim chance that they will be restored. President Obama has said he'd like to further extend the benefits for a year. However, Republicans consider it entitlement spending, and are opposed.

You will see a 2% increase in payroll tax withholding. You've had a tax holiday since 2010, as part of the Obama tax cuts. No one expects that to be restored as part of negotiations.

If you make less than $250,000, you probably won't see a  further change in your withholding even as the Bush tax cuts are rescinded. That's because it takes a few weeks for employers to make the changes in payroll processing needed. Since most businesses think that the tax cuts will eventually be reinstated, they will wait before undertaking this change.

The new Congress has more Democrats, which slightly shifts the balance of power. If a new deal is negotiated in January, it will be retroactive to the first of the year.

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