Countdown to the Fiscal Cliff

By James Wigderson
Special Guest Perspective for the MacIver Institute

So much for the Mayan calendar throwing us over the “fiscal cliff.” The latest reports are that Speaker of the House John Boehner and President Barack Obama are closer to a deal on spending and taxes that will avoid the automatic spending triggers at year’s end.

Ezra Klein of the Washington Post has reported that Boehner has offered to allow tax rates to go up for those earning more than $1 million, although the final income level will probably be less. In exchange, the deal would include spending cut targets that if they were not met would result in another (more tolerable) sequestration. There would also be an adjustment in how the CPI is calculated for Social Security and other possible changes to entitlement programs.

If no deal is reached, more than just annoying relatives will visit taxpayers in this country this Christmas season. The taxes of fiscal years past will return to haunt us, starting with the expiration of the Bush-Obama era tax cuts.

The Alternative Minimum Tax (AMT) has not been “patched” for the current year or for next year. If the AMT is not fixed, the exemption level will revert to what it was 12 years ago. In addition, some credits like the child tax credit will not be applied against the AMT. This means another possible substantial tax increase for American households.

Unlike the other tax increases that would be applied to income earned in 2013, the AMT increase would have an immediate tax impact on income earned in 2012.

Workers have also been enjoying a 2% cut in the payroll tax for Social Security. That, too, is expected to expire at the end of the year, resulting in less take-home pay for the average employee.

These three ghosts of taxes past will have a substantial impact on household disposable income and could have a tremendous impact on the nation’s economy.

The Tax Foundation has looked at the numbers and found the greatest impact of going over the “fiscal cliff” will be on those median income families in states at the top and the bottom of the income ladder.

Higher income families will be hit disproportionately by changes in the AMT, “particularly those that owe higher than average state income tax, which is deductible under the ordinary tax system but not the AMT.”

However, lower income families will be hit disproportionately by the end of Bush era tax cuts: “the reduction in the child tax credit, the elimination of the 10% bracket, and the reduced standard deduction for married filers.”

These are fixed amounts regardless of income, and therefore will have a disproportionate effect as a percentage of income on lower income taxpayers.

When it comes to median income, Wisconsin does not fall into either extreme, but our state does illustrate the impact of pulling a Bill Murray and going over the “fiscal cliff” with the Groundhog. Figuring the potential tax increase as a percentage of income, Wisconsin ranks 33rd, but that still means a 4.78% increase in taxes.

Using their tax calculator, the Tax Foundation broke down the tax increase for the census metropolitan statistical areas. With a household median income of $88,580, the Appleton area will be hit hardest. Taxes on the median households will go up $2,000 just from the child tax credit being taken away from them. The median household will also see an increase in taxes from the AMT of $430 and an increase of $730 from the loss of the Bush tax cuts.

On the other end in Wisconsin, Janesville has a median household income of $64,994. The median household will not see an increase from the AMT, but taxes will go up $1,000 from the child tax credit getting wiped out. The loss of the Bush tax cuts will mean another tax increase of $939.

This is what Congress and the President will have to take into account when they weigh whether having a deal is better than no deal at all. Boehner and Obama may be able to work out a deal between them, but they will still have to sell the compromise to their respective parties.

On the flip side of the equation, after running up $6 trillion in new debt since taking office, will Obama agree to enough spending cuts to make any tax increase, whether it is raising the rates or merely closing loopholes, palatable to enough House Republicans that a compromise will pass?