In 2011 Congress declared that if it didn’t cut the deficit by $1.2 trillion over 10 years, then automatic spending cuts of that amount would immediately occur beginning January 2, 2013.
Congress failed to act, so unless it quickly changes the law now, cuts of $54.6 billion will automatically occur in domestic programs and an equal amount in defense spending on January 2, 2013.
What programs are impacted: On the domestic side, programmatic spending is slashed indiscriminately, with automatic $54.6 billion across-the-board cuts of about 9% to programs that provide basic human needs, education, public safety, disaster assistance, law enforcement, and much more.
What is protected: On the domestic side, Social Security, Medicaid, most Medicare benefits (no more than 2% cuts), the Children’s Health Insurance Program, and federal pensions. On the defense side, current war-related costs and veterans’ benefits.
Prognosis: Congress has created a train wreck of epic proportions – because it was designed to be that way from the beginning in hopes that it would never to get to this point. The theory of sequestration is that Democrats want no cuts to domestic programs and Republicans want no cuts to defense spending. But it is much more complicated, because Democrats with large defense spending in their districts recognize the jobs and impact on their communities’ economies, and Republicans recognize the devastation to public health and safety by slashing the FAA, FDA, Homeland Security, and more. During the post-election lame duck session, Congress could (a) let all or some of the cuts take effect, (b) shift the burdens away from defense and more to the domestic side (as the House has voted to do), (c) come up with other “pay fors” to avoid across-the-board cuts, or (d) delay sequestration for a few months. Even if Congress fails in the lame duck session to deal with these items by the deadline, the Administration has ways to soften the blows – if a resolution needs to be reached with the next Congress in 2013.
President Bush was elected in part on the promise of returning the federal surplus developed during the Clinton years to taxpayers. Congress passed multiple tax cuts in 2001 and 2003 on a temporary basis, through 2010, at which time they would automatically return to the levels they had been during the Clinton years.
These cuts included reduced individual tax rates, reduced marriage penalty, elimination of certain limits on personal exemptions and itemized deductions, and reduced estate tax.
In the lame duck session in 2010, President Obama wanted to stimulate the economy in different ways, including extending federal unemployment benefits and reducing payroll taxes. To secure their votes, congressional Republicans required that the “Bush-era tax cuts” be continued for two years, until the end of 2012.
Individual Income Tax Rates. Income taxes on individuals will return to levels in place before President Bush took office in 2001: increasing from 10% to 15% for the lowest bracket and from 35% to 39.6% for the highest bracket. Most in Congress currently agree that the rates should not increase for lower and middle-income individuals. The dispute centers on those earning more than $200,000 and couples earning more than $250,000 – something that President Obama ran on and Republicans opposed. Deadline: the lower rates expire Dec. 31.
Prognosis: Some contend that no one wants to go over the fiscal cliff for this, while others speculate that secretly many in Congress want to see it happen to purge the system of this stressor that has prevented compromise and even dialogue on so many issues. Under such an approach, the incoming Congress could get credit for “lowering” taxes in 2013 for so many people. As with sequestration, a quick vote can take place in January to avert any real harm if no deal is crafted by year’s end.
Long-Term Capital Gains Taxes. The top marginal tax rates on long-term capital gains will increase automatically from 15% to 20%. With the addition of the elimination of a 1.2% limit on personal exemptions and itemized deductions (PEP & Pease), and the 3.8% tax for Affordable Care Act imposed on high-income investors, this would add another 5% tax on high-income investors, for a total of 25% on long-term capital gains. Deadline: lower rates expire Dec. 31.
Prognosis: Uncertain; closely tied to individual tax rates.
Qualified Dividends. Taxes on qualified dividends will return from 15% back to a maximum rate of 39.6%. Deadline: lower rate expires Dec. 31.
Prognosis: Uncertain; closely tied to individual tax rates.
Estate Tax. Currently the first $5 million of an estate is exempt from tax, with the remainder taxed at 35%. The exemption will fall to $1 million with the remainder at 55%. Deadline: extension of exemption and lower rate expires Dec. 31.
Prognosis: While both sides want to avoid the complete reversion, they have widely divergent views. The President wants to set the exemption at $3.5 million and a tax rate of 45%, as was imposed in 2009, while Republicans want to eliminate it completely or reinstate the current levels.
Alternative Minimum Tax. The Alternative Minimum Tax was put in place decades ago to ensure that wealthy individuals pay a minimum amount of taxes rather than avoid them through various devices. But the AMT is not indexed to inflation, so every year Congress must enact an “AMT patch” to avoid extra taxes on the middle class. Deadline: Dec. 31.
Prognosis: Unless Congress enacts a patch, more than 27 million Americans will have to pay, on average, an extra $3700 in taxes in 2012. Although it has an overall cost of $92 billion, expect a patch whether or not a deal is struck on the other issues.
Child Tax Credit. Scheduled to return to $500 from current $1,000. Deadline: extension of lower credit expires Dec. 31.
Payroll Taxes. Congress temporarily extended a 2% cut in the Social Security payroll tax so people would have more to spend. Deadline: lower rates expire Dec. 31.
Prognosis: Congress will likely allow this temporary stimulus measure to expire to save $95 billion.
Unemployment benefits. To continue providing $26 billion unemployment benefits to those Americans who still remain unemployed, Congress must extend these benefits before they expire on Dec. 31.
2009 stimulus bill. Various provisions that primarily benefit lower-income families – such as expansions of the child tax credit, a tax benefit for college students, and the earned-income tax credit for larger families and married couples – are set to expire on Dec. 31.
Prognosis: President Obama wants these to continue, while reportedly Republicans want them to expire.
“Doc fix.” Unless Congress acts, the Medicare formula set in 1998 to determine payments to doctors (the Sustainable Growth Rate) will return to its scheduled rate, which will cut payments to doctors by 27%. Deadline: rates revert back after Dec. 31.
Prognosis: While a one-year extension costs $18.5 billion, neither side wants to bear the wrath of doctors, so this likely will get addressed – as it has been every year since 2003, so many time that it has its own nickname.
“Traditional” Lame Duck Issues
Other Looming Hot Fiscal Issues
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