The Looming Fiscal Cliff, 2012 Edition Part 1

Lost in the shuffle of the election and the recent escalation of violence (in Libya, Egypt, Yemen, Tunisia, etc.) is the looming fiscal cliff.  There are a lot of bad economic policies that are slated to take place at the end of 2012 without government action.  In Part 1, I’ll detail the changes and the impacts.  This is a long one because it has lots of tables and graphs.  In Part 2, I’ll lay out what I think is going to happen. 

First and foremost, the 2001 and 2003 tax cuts (most often referred to as the Bush tax cuts, but I call them the current tax rates) are in danger.  The current federal income rates are shown below in real 2011 dollars. 

	Married Filing Jointly
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
10.0%	$0	$17,000
15.0%	$17,000	$69,000
25.0%	$69,000	$139,350
28.0%	$139,350	$212,300
33.0%	$212,300	$379,150
35.0%	$379,150	-

	Married Filing Separately
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
10.0%	$0	$8,500
15.0%	$8,500	$34,500
25.0%	$34,500	$69,675
28.0%	$69,675	$106,150
33.0%	$106,150	$189,575
35.0%	$189,575	-

	Single
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
10.0%	$0	$8,500
15.0%	$8,500	$34,500
25.0%	$34,500	$83,600
28.0%	$83,600	$174,400
33.0%	$174,400	$379,150
35.0%	$379,150	-

	Head of Household
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
10.0%	$0	$12,150
15.0%	$12,150	$46,250
25.0%	$46,250	$119,400
28.0%	$119,400	$193,350
33.0%	$193,350	$379,150
35.0%	$379,150	-

These are the 2000 tax rates adjusted into real 2011 dollars via the CPI, which is roughly what we would revert to.

	Married Filing Jointly
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
15.0%	$0	$57,137
28.0%	$57,137	$138,055
31.0%	$138,055	$210,372
36.0%	$210,372	$375,725
39.6%	$375,725	-

			Married Filing Separately
Marginal			Tax Brackets
Tax Rate			Over			But Not Over
15.0%			$0			$28,569
28.0%			$28,569			$69,027
31.0%			$69,027			$105,186
36.0%			$105,186			$187,863
39.6%			$187,863			-
			Single
Marginal		Tax Brackets
Tax Rate		Over			But Not Over
15.0%		$0			$34,204
28.0%		$34,204			$82,807
31.0%		$82,807			$172,780
36.0%		$172,780			$375,725
39.6%		$375,725			-
		Head of Household
Marginal	Tax Brackets
Tax Rate	Over			But Not Over
15.0%	$0			$45,801
28.0%	$45,801			$118,314
31.0%	$118,314			$191,609
36.0%	$191,609			$375,725
39.6%	$375,725			-

In addition, capital gains and dividend taxes would rise.  The current and potential changes are shown below.

Capital Gains Taxation in the United States from 2003 forward[1]
2003–2012					2013–
	2003–2007		2008–2012		2013–
Ordinary Income Tax Rate	Short-term Capital Gains Tax Rate	Long-term Capital Gains Tax Rate	Short-term Capital Gains Tax Rate	Long-term Capital Gains Tax Rate	Ordinary Income Tax Rate	Short-term Capital Gains Tax Rate	Long-term Capital Gains Tax Rate	5-year Capital Gains Tax Rate
10%	10%	5%	10%	0%	15%	15%	10%	8%
15%	15%	5%	15%	0%
25%	25%	15%	25%	15%	28%	28%	20%	18%
28%	28%	15%	28%	15%	31%	31%	20%	18%
33%	33%	15%	33%	15%	36%	36%	20%	18%
35%	35%	15%	35%	15%	39.6%	39.6%	20%	18%

And dividends are detailed here.

Dividend Taxation in the United States: 2003 - [3]
2003–2012					2013 -
	2003–2007		2008–2012		2013 -
Ordinary Income Tax Rate	Ordinary Dividend Tax Rate	Qualified Dividend Tax Rate	Ordinary Dividend Tax Rate	Qualified Dividend Tax Rate	Ordinary Income Tax Rate	Ordinary Dividend Tax Rate	Qualified Dividend Tax Rate
10%	10%	5%	10%	0%	15%	15%	15%
15%	15%	5%	15%	0%	28%	28%	28%
25%	25%	15%	25%	15%	31%	31%	31%
28%	28%	15%	28%	15%	36%	36%	36%
33%	33%	15%	33%	15%	39.6%	39.6%	39.6%
35%	35%	15%	35%	15%

These are massive tax increases.  But, wait, there’s more. 

The Alternative Minimum Tax (AMT) is going to become an issue again.  The AMT was designed to force wealthy people to “pay their fair share” (however you define ‘fair’, I guess), but it was poorly designed, as it was never indexed for inflation, so more and more people are getting snared by it.  It gets patched repeatedly, but never truly fixed. 

I’m not done yet on the tax side, either.  The 2% reduction in personal Social Security taxes that has been in effect for the past two years will expire, too. 

Do the math for yourself and you can see what kind of impact this could have on you.  For me personally, Social Security goes up 2% and federal income goes up 3%.  The AMT doesn’t apply to me, nor do the dividend and capital gain taxes because all my stock activity takes place in my IRA and 401k.  My concerns about the current tax-exempt and safe status of these accounts are another story for another day.

On top of all of that, there is the dreaded sequestration plan, which would mandate spending cuts.  I’ve written previously about this.  Defense and social programs would both be cut aggressively.  But, wait, there’s more.  At least on the defense side, there’s another problem.  The law was written such that it effectively prevents the Pentagon from actually eliminating programs and instead forces them to cut more or less equally across the board from all programs.  So, if the Pentagon had 10 programs of equal size and had to cut the equivalent of one full program, it has to cut 10% from each of the 10 programs rather than fully eliminating one full program.  I suspect this was put in place to blunt the economic impact on the districts of individual members of Congress and I suspect this is also in place for the social spending cuts. Ask yourself how these spending cuts affect you.  The targeted industries are terrified of these impacts. 

Last, but not least, note the lack of impact to Medicare and Social Security (outside of the 2% tax increase).  If we really want to get government spending under control, everything has to be on the table.  Social Security and especially Medicare cannot be exempt because they are the real problems. 

All told, this is a big deal.  This chart from Goldman Sachs tells the story and lays out a couple scenarios.  This could push the US back into recession or deeper into it, depending on whether you believe we ever exited the collapse.

This story is, in my opinion, underreported in the media because they are so focused on…well…everything else like the election, global violence, sports, etc.  It’s not on their minds, but it is on the minds of people and companies as they try to plan for next year.  Anybody who tries to tell you this isn’t a big deal doesn’t understand how households and businesses plan and doesn’t understand how Washington DC works.

Links:

Complete Guide: http://www.zerohedge.com/print/453134

Capital Gains: http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States

Dividends: http://en.wikipedia.org/wiki/Qualified_dividend  

On Defense Spending: http://timsopinionblog.blogspot.com/2011/08/debt-ceiling-deal-and-downgrade-that.html