January 6, 2013

Analysis: The fiscal cliff rundown

Colin Read

— Once again, Congress dodged a bullet they had fired at themselves. They once again took our nation to the brink and, just in the nick of time or shortly thereafter, passed a half-hearted remedy. Because the problem remains unfixed, they can return to the brink in a few months.

This time, the bullet was a bazooka. A while back, Congress put in place a poisoned pill that must be swallowed Jan. 1 unless Congress could agree to something better.

Anything would be better than across-the-board tax hikes and spending reductions. It was fiscal surgery with a blunt ax. You would think that would be sufficient motivation to create something much better. But, no, why waste an opportunity to threaten another recession.

Problem put off

I do not think that the sequester’s tax increase and spending reductions would decrease household income and consumption sufficiently to plunge us into another recession in itself. However, it could in combination with a global reaction at a time in which other economies, too, are teetering.

Congress did not solve their self-induced fiscal cliff. If they agreed to fire a gun at themselves, they could always agree to not pull the trigger. Instead, they voted to reconsider the so-called sequestration trigger in a couple of months, just when they must also deal with another periodic vote to raise the debt limit.

Normally, a vote to increase the debt limit is routine. After all, only Congress can authorize spending, so Congress is punishing its own folly if it refuses to authorize the president to pay the bills it incurs.

Congress took a strategic turn once again. By creating these crisis points, Congressional leaders try to extract concessions from the executive branch. It seems like the only thing that held dysfunctional politics in check this time were U.S. and global financial markets, ironically enough.

The bill just passed remains misunderstood, perhaps because almost no Congressional representative had a chance to read it through from beginning to end. Let me describe some of its provisions.

Not a balanced plan

First, while this bill was supposed to address the goals of the sequestration, it did not provide a balanced combination of higher taxes and spending reductions that would arrest our debt spiraling out of control. The bill had some spending provisions, but these were mostly routine tax advantages for some special interests. It also renewed the so-called 179 deduction that allows businesses to expense rather than depreciate some capital purchases for another year or two, depending on the type of equipment.

The bill did not confine tax increases to the top 1 percent. Actually, taxes for all wage earners will go up because a temporary 2 percentage point reduction in the payroll tax was repealed. This tax is removed from our paychecks, regardless of our income, but is phased out for earned income beyond about $110,000.

President Obama sought to raise taxes to President Clinton levels for all households with a taxable income over $250,000. He compromised with the Republicans by increasing the highest tax rate income threshold to $450,000. Their earned income tax rate will rise by about 3 percentage points and their non-earned income from capital gains and dividends will also be taxed at a 5 percent higher rate.

However, those with taxable income over $250,000 also experience another tax increase through the phasing out of standard or itemized deductions. This phaseout differs from the deductions cap Romney had proposed, but the philosophy is the same. The rationale is that wealthier households do not need such deductions as working class households may.

The act ensured that many middle-income households who live in high tax and property value states would no longer suffer from the Alternative Minimum Tax. The AMT, designed to ensure top income earners in the 1960s would pay their fair share of taxes, had not been updated and began to hit many moderate income households in high cost states like New York. That problem was reduced significantly.

The final misunderstanding is the meaning of income thresholds of $450,000 for the highest tax bracket and $250,000 for the gradual reduction in deductions. These thresholds are taxable income, after all “first page” incomes and losses are summed to generate “Adjusted Gross Income” and then after all deductions are taken on page two, to generate a household’s taxable income. In fact, for many New York households, these thresholds are closer to $550,000 and $300,000 of gross household income respectively. The higher threshold hits the top 0.2 percent of households rather than the top 1 percent of households as Obama intended.

Not all protected

Overall, the tax act did not protect 99 percent of all households, like many claimed. Nor did it reach down to upper middle class incomes, as others claimed. I am surprised at the inaccuracies in reporting these elements to us all, but I guess I shouldn’t be. After all, much of what happens in Washington seems surreal. 

This legislation is a reasonable, if incomplete, response to an unreasonable situation. I’m afraid, though, that it does not go far enough to solve our fiscal problems. And, while I expect it might cost us half a percentage point in growth, it won’t plunge us into the recession inaction would have created.

Colin Read contributes to and has published eight books with MacMillan Palgrave Press. He chairs the Department of Finance and Economics at SUNY Plattsburgh.