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Originally Published: 11/13/2012


In November 2011 Congress, locked-up over a new budget, appointed a Super Committee to fight it out. However, the decision to let a Super Committee decide our future came with a mandatory result if the Committee couldn’t reach an agreement. As was expected, they didn’t reach an agreement and so the mandate - called sequestration - will take effect January 2013. If you’re wondering why it’s called this, check out the Glossary of Political Economy Terms. The Issue Wonk sent out a special report on this. If you want a refresher, here it is.


It’s officially known as the Budget Control Act of 2011 but has become known as the Fiscal Cliff. This name is pretty much a misnomer since nothing really bad happens right away on January 1st. We have time. But the collection of tax increases and spending cuts to reduce the annual budget deficit by about $607 billion (Congressional Budget Office) is considered so disastrous as to earn this name. What’s truly interesting is that it’s considered disastrous for different reasons.


Revenues:  Conservatives consider it a Fiscal Cliff because the Bush Tax Cuts will expire. Taxes go back to where they were in the 1990s. The top tax rate will go back to 39.6% from the reduced amount of 35%. Taxes on capital gains will go from 15% to 20% but dividends on stocks will be taxed as regular income, not capital gains. Estate taxes will also go up. Current rules exempt $5.2 million from the 35% estate tax. The Act drops the exemption to $1 million and takes the rate to 55%. And the alternative minimum tax (AMT) will automatically apply to millions more citizens.


There are many other tax provisions that will expire, like the Research and Experimentation tax credit, many of which are enacted retroactively. In addition, there’s another provision of the Affordable Care Act that goes into effect. Single filers with incomes of $200,000 or more or joint filers with incomes of $250,000 or more will pay a 3.8% additional Medicare surtax on their investment income, including dividends. According to McClatchy, “Combined, it means higher-income investors would see their dividend tax rate jump from the current 15% to 43.4%.”


So, people are worried that dividends would be less valuable to many investors. And some are claiming that raising taxes on the wealthy will result in a loss of 700,000 jobs. Glen Kessler quite adequately proved that claim false. However, many liberals are also concerned because the Bush Tax Cuts also apply to average people and the Social Security tax holiday will expire, reducing the amount of cash the average person has to spend.


Spending:  The Act also calls for spending cuts split 50-50 between domestic and defense programs. However, Social Security and all programs for the poor and for veterans are “off the table.” Also, there can be no cuts to benefits for Medicare participants. As to payments made to Medicare providers, any reduction is limited to a maximum of 2%. This means that cuts will have to be made to all other programs - the environment, education, etc. - and there's a mandatory stoppage of federal unemployment compensation benefits - giving liberals a reason to call it a Fiscal Cliff.


Stimulus:  Economists are referring to this as a Fiscal Cliff because it is essentially an austerity program like those that have devastated the economy in so many European countries. Remember, half of the spending cuts will come from defense spending, so defense contractors are going to lose a lot of business which means the country will lose a lot of jobs. And cuts to all programs in a bad economy is just not good policy. Just like during the Great Depression, we need government spending to help the sluggish economy. The Congressional Budget Office estimates that “if all that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5% in 2013 . . . That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1% in the 4th quarter of 2013.” Since this report is long, detailed, and difficult reading, Josh Bivens at the Economic Policy Institute has given us a nice summary.


Robert Reich summarized the issue nicely. He wrote: “But if economic growth slows - as it will if taxes are raised on the middle class and if government spending is reduced when unemployment is still high - the deficit becomes larger in proportion. That’s the austerity trap Europe finds itself in. We don’t want to go there. This is why January’s so-called ‘fiscal cliff’ . . . is so dangerous. It’s too much deficit reduction, too soon. Tax increases on the middle class would reduce their spending just when the economy needs that spending in order to keep growing, and cuts in government’s own spending would make the problem worse. . . The way to ensure continued growth is to continue the President’s payroll tax cut and extend the Bush tax cuts for income under $250,000, and continue government spending.”


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