The Fiscal Cliff

It now looks like we’re going to go over “the fiscal cliff.”  This will not be a fall off a steep cliff, ala Wily Coyote, where it is not the fall that hurts, but the sudden stop at the end.  Instead, this will be more like tumbling down a steep hillside, caroming off boulders along the way.  That is because a number of different provisions expire at midnight tonight.  Some will have an immediate effect, and some will only hurt much later.  Depending on who you are, you may not even notice a change, particularly if Congress plays nice with the President and reimplements some or all of the expiring tax provisions.

A very incomplete list, in the order of their immediacy of impact:

Unemployment Compensation

Extended unemployment authorization (beyond 26 weeks) runs out tomorrow.  If you have been unemployed for longer then 26 weeks, your check stops next week.  The Democrats want to extend unemployment benefits, the Republicans do not.

Automatic Sequestration

As part of the deal to extend the Bush tax cuts two years ago, Congress mandated huge, across the board spending cuts in both defense and domestic spending programs, unless a bipartisan commission could put together a plan of tax increases and spending cuts.  The commission failed about a year and a half ago, and nobody has done anything since then.  These cuts take place starting next week.  The odds are very high that Congress will move to reverse this next week, as nobody wants these cuts to take place.

Payroll Taxes

Specifically, the Social Security taxes that are paid on earned income.  For the last two years, the portion of Social Security taxes paid by the individual was dropped from 6.2% to 4.2%.  That ends Tuesday.  Congress has a week to decide what they want to do about this before it begins to bite.  The check you get next week will be taxed at the lower rate.  After that, plan on paying another 2% in taxes.  For the long term health of Social Security, those rates will probably have to rise.

Dividend Taxes

In 2012, dividends were taxed at the same rate as capital gains.  That was a piece of the Bush tax cuts.  Without Congressional action, in 2013 dividends will be taxed as ordinary income, at the same rates you pay on earned income.  The tax does not actually come due until the end of 2013, but if you have a lot of dividend income, you should increase your estimated tax payments by the end of the 1^st quarter.

Income Tax Rates

These revert back to the level they were at the end of Bill Clinton’s Presidency.  There is a lot of wrangling over whether the top rates should increase, and what the threshold of income should be if they do.  Unless you make over $250,000, nobody, and I mean nobody in Congress or the Executive branch wants those rates to increase.  Look ofr a deal on that to conclude next week.  Unless you change your withholding, you should see no impact from this until the end of 2013.  If Congress and the President get their act together, they will make the retention of the old income tax rates retroactive to the first of the year.

Alternative Minimum Tax

The AMT is a separate tax system that is run in parallel with the ordinary income tax.  The AMT is designed to make sure high income taxpayers pay some income tax, no matter how many exemptions and deductions they have under the regular tax system.  The problem is that the definition of “high income” was set back in 1982.  Every year Congress has to pass a patch that adjusts for inflation.  Without the patch, millions of what are now middle income taxpayers will have to pay the AMT, which will increase their tax burden.  Congress has until next December to pass a retroactive patch to cover 2013.

Debt Ceiling

It’s baaaaack!  Congress increased the amount of debt the government is authorized to carry by $2 trillion two years ago.  That money is spent.  By March the Treasury Department will lose the ability to borrow more than it already has.  That will mean Federal spending will have to shrink by the equivalent of 7% of GDP.  Look for a repeat of the big fight we saw two years ago on increasing the debt ceiling.

It may look like total incompetence on the part of our elected officials, that they have allowed so many provisions of the current tax regime to lapse, when both sides agree that they do not want to cut spending or raise taxes as much as will happen.  But the controlling dynamic in Washington appears to be positioning your self, not to take credit for what is done, but to throw mud on your opponent for what fails to be done.

All is not lost, however.  It now looks like a farm bill will pass at the last minute, saving milk prices from doubling.