Mitt Romney and Barack Obama, along with surrogates too numerous to count, constantly accuse each other of not having a specific plan to guide the nation back to prosperity. Voters overwhelmingly would accept a combination of higher taxes and spending cuts that their elected leaders have been incapable of embracing. So the two sides just whale away at each other and hope their respective faithful will turn out in enough numbers in key swing states to carry the day.
[Read Top 10 Individual Tax Breaks.]
Despite who wins the White House, the last two months of the 112th Congress are expected to be dominated by continued battling over sizable tax increases and spending cuts set to be automatically triggered when the falling Times Square ball ushers in 2013. Mix in trench warfare over health reform and entitlements programs, and you have a recipe for continued gridlock.
The major components of what has come to be known as the fiscal cliff include the expiration of the big tax cuts approved in former President George W. Bush's first term. All taxpayers would be affected. The lowest tax bracket would rise from 10 to 15 percent. The next three brackets—now 25, 28, and 33 percent—would each rise 3 percentage points. The highest bracket would go from 35 percent to 39.6 percent.
In addition, the tax rate on capital gains (for investments owned for a year or more) would rise to 20 percent from 15 percent. And income from dividends would be taxed as ordinary income instead of the current rate of 15 percent. There are health-reform Medicare tax increases for higher-income households. And the very generous rules on estate taxes—an exclusion of $5.5 million and a top tax rate of 35 percent—will automatically be changed to only a $1 million exclusion and a top rate of 55 percent.
If that's not enough, the 2-percentage point reduction in Social Security payment taxes, in effect for two years, is also set to disappear. And federal spending would drop next year by slightly less than $100 billion, courtesy of the automatic sequestration spending cuts that will kick in because Congress could not agree on a deficit-reduction package last year.
The total of higher taxes and lower government spending is between $500 billion and $600 billion in 2013. That's a 4 to 5 percent hit to economy activity, and is enough to send the economy into recession, according to reports from the nonpartisan Congressional Budget Office and most other experts. Even most Republicans who say that big cuts in government spending would unleash business investment and entrepreneurial energy agree that the fiscal cliff might just be too much of a good thing too fast.
Left unsaid is the fact that even such harsh medicine would close only half of the trillion-dollar federal deficit. And it would not touch rising deficits for Medicare, Medicaid, and Social Security. With or without health reform, healthcare spending will rise along with the numbers of older Americans. Social Security's issues remain relatively modest but they do need attention.
Belief in the quick and painless fix remains high in the United States. Surely there's enough waste in government spending to make enormous cuts with no adverse effect? The ideological answer is yes. The factual answer is no.
There is, by way of one notable example, more than $1 trillion a year in tax breaks embedded in the U.S. tax code. Can't we reform taxes, lower tax rates at the same time, and still add monies to federal coffers and reduce our deficit? It looks like the answer is no, or at best, not by very much.
Last week, the staff of the Congressional Joint Committee on Taxation sent a letter to the Senate Finance Committee that tested exactly this premise. The study assumed these changes: no individual alternative minimum tax (AMT), no itemized deductions, taxing dividends and capital gains as ordinary income, and repealing the tax exemptions of interest on state and local municipal bonds. To keep the study simple and timely, many tax breaks involving low-income, healthcare, and retirement income benefits were not included.
Using the higher tax rates set to take effect next year, the study calculated how much these rates could be cut if the tax breaks were limited and overall federal revenues stayed the same. Keep in mind that the five new tax brackets are set to rise to 15 percent, 28 percent, 31 percent, 33 percent, and 39.6 percent. Under its study, the Joint Committee staff said, these bracket rates could be reduced to 14.4 percent, 26.88 percent, 29.76 percent, 34.56 percent, and 38.02 percent.
That's a 4 percent cut in tax rates. It does not raise a penny of new revenue. And it assumes that the Bush tax cuts are allowed to lapse. If those lower rates stay in effect, even if only for households making less than $250,000, it would be hard to find ways to cut taxes by removing tax breaks.
The Joint Committee's work, along with that of the CBO and any number of other experts, puts the lie to the idea that there is any painless way out of this mess. And don't you think the folks in Congress have known this for years? Of course they have.
They've also known that voters have repeatedly tossed truth-tellers out of office. This leads to avoiding confrontations with what, in discussing global warming, former Vice President Al Gore called inconvenient truths. Ignoring such truths doesn't make them go away and usually makes their impact worse when it finally does arrive.
The fiscal cliff is one such impact, and its effects would not be trivial. But they still would represent little more than a down payment on decades of deficit spending and failed Washington leadership.