Is Fiscal Cliff Too Steep?

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AMERICAN HORSE COUNCIL — NOV. 15, 2012 — The elections are over and Congress has returned for a lame duck session to deal with the “fiscal cliff,” a name given to the many tax measures that are due to expire, and automatic spending cuts that are due to kick in, on January 1, 2013. If nothing is done, current income tax rates (the Bush-era tax cuts) would go up about 4% for virtually every taxpayer, tax rates on capital gains and dividends would rise, the alternative minimum tax would go up for millions, Medicare reimbursements to doctors would decrease dramatically, and defense spending and other discretionary spending would be automatically cut over $100 billion in 2013. All of this would kick in on January 1, 2013, and these are only the most important items.

A recent study by the Tax Policy Center found that expiration of the Bush-era tax cuts would raise taxes by more than $500 billion next year alone. Most economists agree that without some action by Congress to keep all of the tax provisions from expiring at the end of the year and the spending cuts from kicking in, the economy will go back into recession. Yet, whatever Congress does to deal with the “fiscal cliff” will almost assuredly add to the projected deficit, at least in the near term - a predicament that no one much likes either. So what is likely to happen?

Right now it is safe to say no one really knows. But the President and most members of the House and Senate from both parties agree something has to be done not only short-term to avoid the “fiscal cliff,” but also long-term to deal with the increasing U.S. debt. The word “compromise” has actually come up in the discussions.

A bi-partisan group of Senators has been working to come up with a plan which could be acceptable to a majority of both houses. The plan would involve an agreement on the amount of the deficit reduction - for example $4 trillion over 10 years is being discussed. To come up with the money needed to reach the $4 trillion reduction, revenue would be raised by an overhaul or reform of the tax code, savings from changes to social programs, such as Medicare and Social Security, and cuts to federal programs. Once the framework is adopted by both the House and the Senate in the lame duck session, the lawmakers would vote, also in the lame duck session, on expedited instructions to the various Congressional committees of jurisdiction to write the details of the agreement during the first six months of 2013, although it could take longer.

If the first plan cannot be agreed to, the White House and Congress might fall-back on the roadmap provided by the Simpson-Bowles Deficit Commission recommendations to reduce the deficit by $2 trillion over 10 years through changes to Social Security, broad cuts to federal programs, and changing the tax code to lower overall rates and eliminate or reduce enough deductions and credits to yield as much as $2 trillion in additional revenues. Again, this could not be accomplished in the lame duck session, but would have to be done over some set period in 2013.

If one of these plans is adopted, Congress would then vote in the lame duck session to put off the automatic spending cuts and tax increases scheduled to happen in January, 2013. This action could be coupled with some deficit reduction as a down payment toward the ultimate goal.

It’s easy to see that reaching an agreement on a plan similar to either one of the two plans discussed above or any other meaningful long term debt reduction bill may well be a “cliff too steep” to climb during the few weeks available in a lame duck session, but at least all the parties are talking about solutions.

What happens if no comprehensive deficit reduction plan is adopted in the lame duck session, which is a possibility? Under those circumstances, as a final roadblock to the cliff Congress could strike some deal that keeps all or most of the Bush-era tax cuts in place and postpones the effective date of some of the Defense Department automatic cuts into next year, say for three to six months. This deal may also include raising the tax rates on higher income taxpayers, perhaps those making over $500,000 annually, to the rates in effect prior to the Bush-era tax cuts. Passage of this deal would move the “cliff” down the road for a few more months and give Congress a chance to address seriously the unsustainable deficits that were so well described in the Simpson-Bowles Deficit Commission.