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The Fiscal Cliff - Explained

Social Security taxes will also go up to 6. The AMT is a flat tax, usually for people who earn a lot of money. Right now, it applies to about 4 million people. If we go off the fiscal cliff, it will apply to 32 million people, which means a lot of people who consider themselves middle-class will have to pay taxes as if they are rich. It is extremely likely that Congress will "patch" the AMT, though, even if it does nothing else for the next 46 days. You said my tax bill will be bigger if we go over the fiscal cliff. It depends on your income bracket.

The first school says that nothing will happen — that Congress will not allow us to go over the edge, that they'll come up with some sort of temporary solution, and that we'll revisit the whole mess in six months. But some say Armageddon will draw near around say, December 20, as the deadline draws closer and Congress still has nothing to show for its efforts. That Armageddon is a psychological effect that will create a financial one.

Investors will start panicking in the stock markets, which could start falling sharply. Then the business community will panic, because they won't know what their taxes will be for the next year. As we draw closer to the fiscal cliff deadline, those panicked CEOs could stop spending and hiring.

That, in turn, would hurt the chances of seeing the unemployment rate fall. It also could destroy the tentative recovery. All of that would not happen immediately; it takes a few months for growth to slow down, and unemployment likely won't rise right now. But, many people say: Everyone agrees that the Bush tax cuts should be extended for the middle class, so that middle-class households can keep their low tax bills. The president is adamant that those high-earners will have to pay higher taxes.

But John Boehner and his team of Republicans are dead against it. It's hard to imagine they'll come up with a solution to the US tax code in the next six weeks. The duo — "two old coots", in Bowles' own quip this week — are the elder statesmen of federal budget battles. Bowles helped balance the federal budget in It's never been balanced again since.

The Bowles-Simpson plan included tax hikes and spending cuts. It also called for raising the retirement age for social security; cutting government pensions, subsidies for farmers and student loans. The president ended up lukewarm on the plan, though, and it has never taken off and probably won't. There's also the Domenici-Rivlin plan, which looked to replace the current tax code it with two income-tax rates: This would effectively raise taxes on the rich without actually changing tax rates. However, it might also hit charities, since they get a lot of money from wealthy donors who benefit from the tax breaks on philanthropy.

So let's start at the beginning: Why are the cuts this year so sudden and hard to take? It's called the fiscal cliff because it's a catchy term. The word fiscal is like a sleeping pill. True, but it's catchier than "a blend of sequestration and tax hikes". How about the tax hikes? Well, there are two schools of thought on this. So what are Congress and the president doing for the next month?

This directed automatic across-the-board cuts known as "sequestrations" split evenly between defense and domestic spending, beginning on January 2, At the end of , the patch to the AMT exemptions expired. Anyone over these reduced thresholds at the end of would be subject to the AMT. Therefore, more taxpayers would pay more unless some legislation was passed as was done in that affects the exemptions retroactively. The fiscal cliff was finally eliminated at the very last minute during late-night and early-morning sessions of congress on New Year's Eve and New Year's Day.

CBO projections of the sources of deficit reduction in the FY budget, not counting economic feedback. A number of laws led to the fiscal cliff, including these provisions: Without new legislation, these provisions were to automatically go into effect on January 1, Some lawmakers had intended to attach a bipartisan extension to the expiring wind-power tax credit.

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Proposals to avoid the fiscal cliff involved repealing legislation containing certain of these provisions or passing new legislation to extend provisions that were due to expire. Different proposals were to include changes to some or all of the above provisions. For example, the Congressional Budget Office 's "Alternative Fiscal Scenario" included only the first four items above.

The spending reduction elements of the fiscal cliff are primarily contained within the Budget Control Act of , which directed that both defense and non-defense discretionary spending [note 1] be reduced by "sequestration" if Congress was unable to agree on other spending cuts of similar size. The scope of the law excludes major mandatory programs such as Social Security and Medicare. As of January [update] , Congress was unable to reach agreement on spending cuts and the sequestration was delayed until March as part of the American Taxpayer Relief Act of The effect on discretionary spending will be significant if the sequestration is not avoided.

During , discretionary spending would be maintained around levels due to the sequester. However, the spending begins to rise thereafter, but not at the pace projected prior to the sequester.


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In other words, the trajectory of spending increases is reduced, but spending is not frozen at levels. Increases in discretionary spending from to would be about 1. Non-defense discretionary spending grew at a 6. The CBO estimated the possible impact on defense spending in October testimony: For example, defense and nondefense appropriations might be cut proportionally relative to the funding that would be necessary to keep pace with inflation.

When measured as a share of GDP, funding for defense would decline by about 1 percentage point from to , or by more than one-fourth see Table 5. Funding for defense in excluding overseas contingency operations would represent 2. The CBO estimated the possible impact on non-defense discretionary spending in October testimony: Under an assumption that the obligation limitations for certain transportation programs grow over time at the rate of inflation, nondefense funding in would represent 2.

Loren Thompson of the Lexington Institute has noted that, as entitlement programs are largely exempt from the mandated cuts, sequestration would result in these programs assuming a larger percentage of the reduced budget, while spending on other programs such as defense would make up a smaller percentage of the budget.

Secretary of the Navy Ray Mabus has said that continuing to operate under a series of continuing resolutions would be just as bad as sequestration, because these would freeze all programs at last year's spending levels, instead of allowing each program to adjust to its current situation. The military has already cut spending in anticipation of sequestration. Truman deployment, which marked an end to the policy of keeping two carriers in the Persian Gulf region.

However should sequestration come into effect, it would simply reduce defense spending to the inflation adjusted cold war average. On 20 February , Defense Department Controller Robert Hale said that rather than cancelling contracts outright, the DoD would instead use furloughs and simply not exercise contract options for supplies and services. Ray Odierno warned that the lack of training in due to sequestration had already impacted on Army readiness.

The sequestration mandated cuts in drug enforcement are expected to result in a doubling of cocaine imports into the United States. Various sources have estimated the impact on taxpayers from the tax increases that would have occurred if the Bush income tax cuts and the Obama payroll tax cut had been allowed to expire with the fiscal cliff.

United States fiscal cliff - Wikipedia

The table below shows the dollar and percentage increase in income taxes for the tax year, if the fiscal cliff had taken effect. Each piece of the fiscal cliff would have had varying effects on people at different income levels. Low-income households are most affected by expiring expansions of the child tax credit and earned income tax credit. Middle-income households are affected most by the payroll tax and income tax.

Households at the top income level are most affected by the income tax and the tax increases on unearned income such as capital gains. Although European companies and investors will hardly see any direct taxation effects, corporate taxation of their U. While Congress was debating actions to take to mitigate the fiscal cliff, the Congressional Budget Office provided policy-makers with projections of two fiscal scenarios for the years to These painted starkly different fiscal futures. If Congress and the President did not act, allowing tax cuts to expire and mandated spending cuts to be implemented, the next decade would have more closely resembled the baseline projection.

If they acted to extend current policies, keeping lower tax rates in place and postponing or preventing the spending cuts, the next decade would more closely resemble the alternative fiscal scenario. The CBO has been publishing baseline projections, following existing law, since Future deficits would be reduced from an estimated 8. This would mean a high probability of recession a 1.


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If Congress had "avoided" the "fiscal cliff" by continuing its existing policies, the future would have more closely resembled the CBO's "alternative fiscal scenario". This scenario involved extending the Bush tax cuts, repealing the automatic spending cuts, restricting the reach of the AMT, and keeping Medicare reimbursement rates at existing levels the so-called " doc fix ", versus declining by one-third. This scenario has considerably higher debt and interest payments than the baseline projection, but the short-term impact on the economy would have been avoided.

The Congressional Budget Office estimates that allowing certain laws on the books during to expire or take effect in the baseline scenario would cut the deficit approximately in half and significantly reduce the trajectory of future deficits and debt increases for the next decade and beyond. However, the deficit reduction would adversely impact the economy in the short-run. On the other hand, if Congress acts to extend current policies the alternative scenario , deficits and debt will rise rapidly over the next decade and beyond, slowing the economy over the long run and dramatically increasing interest costs.

The CBO has identified the following metrics for its baseline and alternative scenarios for the period starting January Consideration of these scenarios and other options [note 2] leads to what the CBO calls "a broad spectrum of fiscal policy choices. Therefore, since the total U. The pie chart to the right contains a breakdown of the currently authorized reductions to the FY deficit.

Reduced taxes and increased spending, due to the 1. The CBO reported in November the economic and employment effects of various policy options related to the cliff. Each option has a different GDP and employment impact per dollar of deficit impact. In other words, some choices are economically more efficient.

CBO explained why spending cuts have a more significant adverse impact on the economy than tax increases per dollar of deficit reduction: On July 25, , the Democratic-controlled U.

The Senate also rejected the Republican proposal of extending the tax cuts for all by 45— House of Representatives rejected, —, the President's tax proposal on August 1, Senior White House officials recommended a veto of any bill that: Congressional Republicans have proposed that the Bush tax cuts be extended in their entirety. Revenue would be generated mainly by reducing tax expenditures exemptions and deductions rather than increasing income tax rates. Further, it included raising the Medicare eligibility age from 65 to 67 and slowing increases in Social Security costs by reducing cost-of-living adjustments.

The patch prevents the AMT from affecting many more taxpayers. This is similar to what Congress has done in previous years. On December 12, , the Federal Reserve announced it would keep short-term interest rates near zero percent in an effort to lower unemployment to 6.

The fiscal cliff explained: what to know about the biggest story in Washington

The US debt ceiling became involved in the fiscal cliff debate when Treasury Secretary Timothy Geithner introduced the President's authority to raise the country's borrowing limit as a part of his first formal proposal. On December 26, , Geithner announced that the federal government would exceed the current debt ceiling on December 31, Therefore, a number of measures would be put into place to delay this from happening, starting with suspending issuance of State and Local bonds on December 28 and investing in two government pension plans.

These and other measures would normally delay reaching the debt ceiling for about two months but, because of debate over the fiscal cliff, this might be extended if there is no change in the current laws. According to former Secretary of Defense Robert Gates, the deep across-the-board cuts in defense spending required by the Budget Control Act will threaten military-dependent local economies and "do great damage" to American military strength and homeland security.

Many experts have argued that the U. He recommended the adoption of ideas from deficit panels such as Domenici-Rivlin and Bowles-Simpson that accomplish these two goals. Other experts at the Center on Budget and Policy Priorities and the Carlyle Group have argued that allowing the tax increases and spending cuts to occur under current law may be necessary to create the "grand bargain" required to get the U. In other words, allowing current law to take effect would create conditions under which legislators might be forced to enact better designed deficit reduction approaches of similar or greater magnitude.

Patrick Knudsen, a Heritage Foundation fellow, argued that lawmakers should seek long-term stability by rejecting short-term fixes and "grand bargains. This table [94] [95] contains a comparison of the official proposals and counter-proposals from President Obama and Speaker Boehner, as of December 18, It does not include leaked or partial information about one specific aspect of an offer nor does it include partisan votes in the House or the Senate. The bill faced uncertain prospects in the House of Representatives as Eric Cantor , the House Majority Leader , said on January 1 that he did not support it.

The act contains the following provisions: This would be the first year-to-year income-tax rate increase since The new rates for income, capital gains, estates, and the alternative minimum tax would be made permanent. The passage of the bill came after days of negotiations between Senate leaders and the Obama administration, with the final agreement being attributed to talks between Vice President Joe Biden and Senate Minority Leader Mitch McConnell. Some Democrats criticized the bill for not raising taxes on the wealthy more, while Republicans criticized it for raising tax rates while not providing explicit spending cuts.

While ATRA would reduce short-term economic impact due to the cliff, it would slow long-term growth relative to the lower deficit Baseline scenario. The table below shows the estimated impact on taxpayers from the tax increases that occurred with the expiration of the Obama payroll tax cut and partial expiration of the Bush income tax cuts.

The estimated impact is given as an average for the different income levels. The baseline that is used is if the payroll tax cut had been extended, new health care tax not implemented, and Bush income tax cuts fully extended. Average federal taxes include individual income taxes, corporate income taxes, payroll taxes, and estate taxes as a percentage of average cash income. The sequestration fight was then expected to occur during negotiations over a debt limit increase that was expected to be needed sometime in February. The bill did not include any offsetting budget cuts, as Republicans had previously stated as a precondition for raising the debt limit.

The move was seen as an attempt to delay a showdown on the debt limit given their experience with the debt-ceiling crisis , as well as the recent Democratic gains in the elections. On January 31, , the Senate approved and the House passed debt limit bill H.

The May 18 deadline is after the March 1 deadline for the sequestration, and the March 27 expiration of the continuing resolution funding the federal government. The bill also included a provision that would delay the salaries of Congressmen of any house that had not passed a resolution on the FY budget by April 15, From Wikipedia, the free encyclopedia. This is the latest accepted revision , reviewed on 17 July This article is part of a series on the Budget and debt in the United States of America Major dimensions.

Medicare Social programs Social Security. Budget sequestration in Debt-ceiling crisis of Financial crisis of — Balance of payments Inflation Continuing resolution. Expiration of tax cuts and the subsequent growth in the AMT: Other expiring tax provisions: Affordable Care Act taxes: Spending cuts "sequestration" under the Budget Control Act of Expiration of federal emergency unemployment insurance: Reduction in Medicare payment rates for doctors: Other changes mostly revenue, primarily reflecting economic growth: American Taxpayer Relief Act of United States debt-ceiling crisis of This is as opposed to mandatory spending: Slightly more than half of the discretionary money went for defense.

The rest of the discretionary spending funded a wide variety of government programs and activities, including education, veterans' benefits, public health and the administration of justice. Both would have implemented the original caps on discretionary appropriations contained in 's Budget Control Act and allowed the new taxes for the Affordable Care Act to come into effect. They act against the primary purpose of avoiding the fiscal cliff, either increasing spending or decreasing taxes.

Retrieved February 25, The New York Times. Retrieved January 1, The Wall Street Journal. Retrieved 6 November The bill was not posted online 24 hours ago. But perhaps he can be forgiven since the U. Great West Financial Retirement Services. Retrieved 13 August Retrieved October 9, Lots of Names for Year-End Event".