How Fiscal Cliff Shapes Up After Election

Lots of talk about the fiscal cliff begs the question: so what will transpire with all election outcomes?

The fiscal cliff looms large. It should. Unless Washington does something, 2013 will face a sudden and automatic fiscal restraint. The shock would almost certainly drive this economy’s already enfeebled recovery into recession. It is a frightening prospect, to be sure, but, still, likelihoods suggest that even this Congress will steer clear such a cliff.

Warnings on this matter have emerged through several channels. Federal Reserve Board Chairman Ben Bernanke, at last summer’s testimony on monetary policy, forcefully called Congress’ attention to the impending problems and, incidentally, coined the phrase “fiscal cliff.” The Congressional Budget Office (CBO) followed up with a full analysis, concluding that, if something is not done, restrictive automatic fiscal measures in 2013 could exceed $800 billion and force this economy into at least two quarters of decline. And though there is always room to cavil, surely the CBO’s analysis and conclusions are reasonable. Severe problems are built into law on both the spending and on the revenue sides of the federal budget.

Taxes on investment income also would rise. Currently, Washington takes 15% of long-term capital gains. That, in the absence of some action, would rise to 20%, not counting the added Medicare take, which would take the rate to 23.8%. Taxes on qualified dividends would rise from the current 15% to the rate on ordinary income, which itself would rise to 39.6% from 35%.  Counting the added Medicare levy would take this rate up to 43.5%.  According to the CBO, these further tax impositions, avoiding any double counting for the Medicare and income-tax hikes already accounted for, would add another $50-100 billion to tax liabilities. In total then, the expected tax hike for 2013 would rise upwards of $600 billion, the biggest peacetime tax increase ever.

On the spending side, the biggest item is the budget sequester.  As part of the debt ceiling compromise of 2011, Congress bound itself to automatic spending reductions, mostly on the discretionary side of the budget, if it failed to make strides in fundamental deficit reduction. That failure, according to the CBO, would produce spending cuts for 2013 of some $87 billion. Since emergency unemployment benefits also would end, the year 2013 would see an additional $35 billion in spending cuts. The failure to pass the annual upward adjustment in Medicare doctors’ fees, referred to in Congress as the “doc fix,” would hold back spending another $15 billion. On top of these effects, the CBO indicates, without itemizing, that miscellaneous aspects of fiscal restraint would amount to another $140 billion.

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About the Author

Milton Ezrati

Milton Ezrati

Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. His latest book, Thirty Tomorrows, linking aging demographics and globalization, will appear next summer from Thomas Dunne Books of St. Martin’s Press. See more of his articles about the economy here.

 

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