Why the fiscal cliff is like getting a huge paycheck cut

NCC Staff

As rival lawmakers struggle to avoid the dreaded fiscal cliff in Washington, research shows that Americans will get a huge cut in their take-home pay if Congress can’t reach a deal on tax hikes and spending cuts.

Source: Wikimedia Commons

In basic terms, the fiscal cliff is a set of dramatic tax increases and government program spending cuts that would decrease the annual deficit run up by the federal government.

It was put into a debt-negotiation process by lawmakers as a “poison pill,” an alternative so politically toxic that it would force Democrats and Republicans to agree, or face an angry mob of voters.

But an agreement was never reached in 2011, and now, the stark tax increases and spending cuts become law on January 1, 2013, unless a bipartisan agreement can be reached or the problem is pushed back into the hands of a new Congress.

The math behind the fiscal cliff can be quite complicated, but to see why politicians are scrambling to find a solution now, you only need to look at how the cliff would suck money out of voters’ paychecks, if the fiscal cliff goes unchecked.

As a rule, Americans don’t like taxes, and they don’t like dramatic tax actions. Look back at the original Tea Party in Boston as an example.

A study from the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution, shows that tax hikes triggered by the cliff will “dock the pay” of 90 percent of Americans.

“Taxes would rise by more than $500 billion in 2013—an average of almost $3,500 per household—as almost every tax cut enacted since 2001 would expire. Middle-income households would see an average increase of almost $2,000,” the group said in an October 2012 report.

The telling factor in the Center’s report is that after-tax income will fall in every tax bracket, at an average of 6.2 percent.

In other words, instead of getting a 6 percent raise in 2013, you’d have your take-home pay docked 6 percent, before your employer even had a chance to give you a raise.

About 40 million Americans in the lowest fifth of the economy would see take-home income fall 3.7 percent. Taxpayers in the top fifth of the economy would see a 7.7 percent drop. Middle income tax payers would see take-home income fall by 4.4 percent.

Fiscal Cliff Changes in Take-Home Pay
Percent Dollars
Lowest quintile -3.7% $        412
Second quintile -4.5% $    1,231
Middle quintile -4.4% $    1,984
Fourth quintile -5.1% $    3,540
Top quintile -7.7% $  14,173
Average -6.2% $    3,446

The tax changes hit Americans from all angles. The biggest hit is from the expiration of the Bush-era tax cuts, but there are also Obama-era tax cuts and credits that expire.

There will be tax penalties for married couples and for families with children. And the dreaded Alternative Minimum Tax is in the mix, which would increase taxes for 22 million people.

So income taxes would go up, payroll taxes would go up, and estate taxes and dividend taxes would go up.

And there is a new tax to pay for the Affordable Care Act.

If there is a silver lining, the federal government would bring in an extra $536 billion in 2013 to use for deficit reduction. About 54 percent of that money would come from ending the Bush-era tax cuts and from new payroll taxes.

The health-care tax would take up about 5 percent of the overall tax hikes.

To get a different look at how the tax changes would affect your family, the Tax Foundation has an online calculator that lets you put in your income and deductions and see your actual tax hike under different scenarios.

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The Foundation has its critics, which say it is a conservative-leaning group.

But when we added data from the calculator on a married couple, with two children, making $60,000 annually, the tax-home pay number was similar to the information from the Tax Policy Center.

In most middle-income scenarios, the Foundation calculator shows take-home income falling by about 5 percent.

Its calculator also lets you pick different scenarios for dependents and dropping the Alternative Minimum Tax.

For now, President Obama and House leader John Boehner aren’t speaking, and the Democrats and Republicans are presenting the tax and spending plans to Americans, in advance of a big congressional showdown in December.

Obama is committed to extending tax cuts for the middle class and hiking taxes on wealthier citizens. The GOP is committed to deep spending cuts in “entitlement” programs as part of any fiscal cliff bargain, which would include sparse tax hikes.

The most anxious watchers are Wall Street and its partners in the global economy, which are very much aware of Congressional Budget Office projections of a 2013 recession if the fiscal cliff goes into effect.