What is the fiscal cliff?

Everyone seems to be talking about the “fiscal cliff” lately but many people only have a general idea what it entails, why it is occurring, and the impact businesses and taxpayers can expect from it.

What is the fiscal cliff and why is it happening?

The term “fiscal cliff” is used in discussion regarding the United State’s bundle of considerable tax increases, set in motion ten years ago, that are scheduled to take effect at the end of this year and into early 2013 unless the White House and Congress agree on how to reduce the budget deficit during the next decade. Also, $1.2 trillion in government spending cuts during the next decade would be triggered automatically under legislation from 2011.

Economic experts believe that “if America does go over the fiscal cliff, businesses could respond by sharply curtailing business investment. That will return America to recession and, perhaps, deepen recession all across the world” according to Christopher Lockwood, U.S. editor of “The Economist”. Here’s a video that Christopher Lockwood put out discussing the fiscal cliff.

At the end of the day, U.S. lawmakers have a choice: they can either let current policies go into effect at the beginning of 2013 and possibly drive the country back into a recession – or cancel some, or all, of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a predicament similar to the debt crisis Europe endured a few years ago.

Revenue Increases in detail

  • 2001/2003/2010 Tax Cuts & AMT Patch:  This series of legislation, often referred to collectively as the “Bush tax cuts,” will expire on December 31, 2012, raising all income tax rates (top will go from 35 to 39.6 percent), as well as rates on estate and capital gains taxes. The alternative minimum tax (ATM) will also automatically apply to millions more citizens.
  • Payroll Tax Cut:  The Social Security payroll tax holiday will expire December 31, 2012 raising the rate from 4.2 to 6.2 percent.
  • Other Provisions:  A number of other policies such as the Research and Experimentation tax credit, many of which are typically enacted retroactively, are due to expire at years’ end.
  • Affordable Care Act Taxes:  Some provisions in the Obama health care legislation, including increased tax rates on high-income earners, are set to take effect in January 2013.

Spending Cuts in detail

  • Budget Control Act:  The automatic spending cuts legislated by the Budget Control Act of 2011 will hit January 2. Half of the scheduled annual cuts ($109 billion/year from 2013-2021) will come directly from the national defense budget, half from non-defense. However, some 70 percent of mandatory spending will be exempt.
  • Extended Unemployment Benefits:  The eligibility to begin receiving federal unemployment benefits, last extended in February, will expire at year’s end.
  • Medicare  “Fix”:  The rates at which Medicare pays physicians will decrease nearly 30 percent on December 31.

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