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US Fiscal Cliff 2013

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US Fiscal Cliff 2013

Congress did not allow the economy to fall off the fiscal cliff in 2013.

(Credit: Getty Images)

On New Year's Day, the House approved a Senate bill that averted the fiscal cliff. Republicans were unhappy that there weren't more spending cuts, but at least an income tax hike was averted for most Americans.

Here's what the new bill contained:

  1. Bush tax cuts were kept on incomes below the threshold ($400,000 for individuials, $450,000 for married couples). Incomes at and above the threshold will now be taxed at 39.6%.
  2. Capital gains and dividends taxes were raised from 15% to 20% for families at the threshold and above. Estate taxes were raised to 40% of estates above $5 million for those at and above the threshold.
  3. The 2% payroll tax credit was allowed to expire. You've had this since the  2010 Obama tax cuts.
  4. The income level at which the alternative minimum tax kicks in was permanently raised, so it doesn't affect middle-income taxpayers. It is indexed for inflation, so that it doesn't have to be patched year after year.
  5. The extended unemployment benefits will continue for a year.
  6. Sequestration has been postponed for two months. The spending cuts that Republicans want will be part of the normal FY 2014 budget negotiations -- as they should be.

Other Provisions of the Bill

Some exemptions and deductions were extended, such as the mortgage insurance premium (through 2013), the American Opportunity Tax Credit (through 2017) and the Earned Income Tax Credit (permanently). Others will be limited on incomes above $250,000 ($300,000 for married couples. For details on these, see House Approves Taxpayer Relief Act.

The bill takes action on other important points:

  • It prevents a 37% decline in Medicare payments to doctors.
  • It extends federal dairy subsidies through the end of FY 2013. This prevents a hike in milk prices.
  • It does not include a .5% pay raise for Congress proposed by President Obama.
Like most other legislation, the bill contained some last-minute riders to provide a hodge-podge of smaller tax exemptions for special interest groups. These range from tax breaks for NASCAR, Hollywood, and AMTRAK. For more, see Wonkblog, 10 Wierdest Parts of the Fiscal Cliff Deal.

What Made the Vote Possible:

We actually fell off the fiscal cliff for barely 24 hours. Since all Bush tax cuts expired, Tea Party Republicans can't be accused of raising taxes. Instead, they reinstated the tax cuts for incomes at $400,000 or less, and then instituted a smaller tax cut for incomes above that amount.

Congress wanted to vote on the measure before newly elected members took office on Thursday. This shifted the voting power more toward the Democrats, even though the House retained a Republican majority. 

The Disaster That Was Averted:

The fiscal cliff refers to the devastating impact on the economy in 2013 if national leaders allowed four tax increases and two spending cuts to take place at the beginning of the year. According to the Congressional Budget Office, $607 billion in government stimulus would have been removed from U.S. Gross Domestic Product (GDP) between January and September 2013 (These dates correspond to the last nine months of the 2013 Fiscal Year.)

Two-thirds of that ($339 billion) would have resulted from the following tax increases:
  1. Expiration of Bush tax cuts and the ARRA - $229 billion.
  2. Expiration of the 2% payroll tax holiday, part of the Obama tax cuts, - $95 billion.
  3. Expiration of partial expensing of investment properties - $65 billion.
  4. Obamacare tax increases - $18 billion.
The rest would have come from the following reductions in Federal spending:
  1. Sequestration (automatic budget cuts) - $65 billion.
  2. Expiration of extended unemployment benefits - $26 billion.
  3. Reduction in Medicare payments to doctors - $11 billion.
Other, unspecified changes that reduced the deficit by another $105 billion.

Worst Case Scenario:

There was never a real chance that nothing would be done, the worst case scenario. No elected official wanted to be responsible for allowing a recession. That's what the Congressional Budget Office (CBO) predicted, saying the economy would contract 1.3% for the first two quarters of 2013. Even though the CBO projected that the economy would recover, growing 2.3% in the second half of the year, it would have caused more unemployment while only reducing the deficit by $560 billion. That's because people who have been laid off pay less in taxes, translating to lower revenue for the government.

Best Case Scenario:

The best case scenario would have been if Congress extended all tax cuts and kept spending at current levels. In that case, the economy would have grow 4.4% in 2013 according to the CBO. At that growth rate, job creation would rise and the unemployment rate would drop. That would pretty much eliminate the need for extended unemployment benefits, as they are tied to above-average state unemployment rates. More income from wages means that tax revenue would rise, reducing the deficit and debt.

A healthy economy can grow its way out of a high debt-to-GDP ratio. The higher the GDP, the lower the ratio -- as long as spending doesn't increase. For proof, notice that the national debt by year keeps increasing. Even though the debt from World War II has never been paid off, it doesn't matter. Economic growth has since dwarfed it.

However, it's highly unlikely that Congress would support this scenario. Way too many elected officials think that the Federal debt is unsustainable at even a 90% debt-to-GDP ratio. (Source: CBO, Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013, May 2012) Article updated January 3, 2013

Find Out More About What Led to the 2013 Fiscal Cliff:

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