It sounds pretty abstract: If Congress doesn't deal with a bunch of controversial tax and spending decisions by the end of the year, something bad will happen to the economy. But the odds are, negotiators in Washington will come up with some kind of last-minute deal that averts disaster.
That's the general narrative relating to the "fiscal cliff," which means the whole ordeal might come and go with no real effect on ordinary Americans. But there are other worrisome possibilities. Congress could temporarily let a huge set of tax hikes and spending cuts go into effect at the start of 2013, as scheduled, while planning to rescind them later in the year, once the next Congress is seated. Or, Republicans and Democrats could split the difference and allow some of those measures to take effect. There's also the chance that Congress could botch the whole thing—with partisan bickering standing in the way of any kind of deal—and torpedo the entire economy.
The tax hikes and spending cuts due to take effect total more than $600 billion per year—with tax hikes accounting for most of that. So while the policies under debate are somewhat arcane, the outcome could lead to tax hikes for virtually every American if Congress plunges over the fiscal cliff, even temporarily.
The nonpartisan Tax Policy Center says that if all the scheduled tax increases occur, the average household would have to fork over an extra $3,400 to Uncle Sam next year. Here's the average hike taxpayers would face, broken down by income group:
- Lowest fifth of households (average income: $11,239): $412
- Second-lowest fifth (average income: $29,204): $1,231
- Middle fifth (average income: $49,842): $1,984
- Second-highest fifth (average income: $80,080): $3,540
- Highest fifth (average income: $178,020): $14,173
- Top 1 percent (average income: about $1.3 million): $120,537
The biggest hit for most people would come from the expiration of the 2001 and 2003 tax cuts, which would raise income-tax rates for everybody by 3 to 5 percentage points, depending on the tax bracket. Those changes alone would raise the tax rate for a family earning $80,000 from 25 percent to 28 percent, resulting in about $1,450 worth of new taxes.
But there are at least nine different tax hikes due to go into effect in 2013, which is why few taxpayers would escape the noose. For the lowest fifth of earners, the biggest change would be the expiration of temporary tax cuts that were originally passed as part of the 2009 stimulus plan and then extended through 2012. The end of those breaks would raise the tax bill of the lowest quintile by about $329 per year. Other scheduled tax hikes include higher rates on capital gains and other investment income, a lower threshold for the estate tax, and a new tax on high earners to help pay for the Obama healthcare reforms.
Congress can rescind some or all of those, which will be a big part of the negotiations between Capitol Hill and the White House over the next several weeks. But doing so would perpetuate Washington's huge budget deficits and continue to erode investor confidence in the stability of the government's finances. So it's likely that at least a few of the scheduled tax hikes will actually happen. Taxpayers who aren't paying attention to the fiscal cliff probably will be soon.
Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.