As 2013 was approaching, there was a lot of talk of a “fiscal cliff”, little of it being particularly clear. It is not a new phrase, going back at least to 1957. The phrase was used by Ben Bernanke, based on changes in tax law and spending changes that would seriously hamper economic growth. Bernanke stated before the House Financial Services Committee: “Under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases.”
Mainstream macroeconomic theory states that both tax increases and government spending cuts will hurt the economy, despite historical evidence to the contrary.
Cuts in Increases Rather than Spending Cuts
The figure that was often stated in the media is not the actual cuts in spending, but the cuts in proposed increases, and even the given figure was for a decade—which when you think about it, is meangingless. Considering there is an election every two years (for all of the House of Representative members and one third of the Senate), 10 year figures are just posturing. Current politicians can not compel future politicians in any way whatsoever.
The original plan was for spending in 2013 to be the same as in 2012, and then for it to grow 1.5% annually. There were no true cuts planned. This is due to a deceptive government practice called “baseline budgeting.” This means that government spending should automatically grow with both inflation and population, thus a freeze in government spending is a “cut” from the original budget.
According to the Congressional Budget Office, the forecast for government outlays in fiscal 2013 (which began October 2012) is $9 billion dollars less. Notice that $2 billion of the nine billion is a difference in interest payments. This means that the government will only spend $7 billion dollars less on goods and services. To a person or small company, $7 billion might sound like a lot of money, but it is less than 0.2% of the amount spent in fiscal 2012.
What Tax Increases will Americans see in 2013?
1) Social Security
The amount taken from paychecks was supposed to increase from 4.2% to 6.2%. This part of the cliff happened. This new rate applies to the first $113,700 instead of $110,100 as in 2012.
2) Personal Income
The income tax rates were supposed to go back what they were during Clinton’s presidency. The brackets back then were 15, 28, 31, 36, and 39.6%, these were changed to 10, 15, 25, 28, 33, and 35% during Bush’s presidency (the lowest bracket was simply put in under the 15% bracket).
A new income bracket was added at $400,000 of taxable revenue which is 39.6%, so a version of this planned policy became reality.
3) Long Term Capital Gains and Qualified Dividends
Originally, both categories of income would revert back to Clinton levels. This means that dividends would be taxed as normal income.
Also at the $400,000 threshold, taxes on both capital gains and dividends go up to 20%, instead of 15%. This means the actual outcome was very similar to the cliff outcome for capital gains, but dividends’ tax status (while subject to higher rates than before), is still lower than personal income.
The top rate rose from 35% to 40%. See here.
Possible Implications of Current Policies
As usual with these tax increases, less money will probably be raised than expected, because the CBO tends not to consider things like this. Also, stocks and corporate bonds might be abandoned in favor of tax-free bonds from state and local governments by more people now, depending on the income bracket of the person.
The new taxes will be a drag on the economy, especially since they are so oriented towards saving and capital accumulation, rather than encouraging consumer spending. There is a general consensus among economists that tax policy should focus less on investment and income and more on consumption.
The spending difference will have a negligible impact on the economy, which seemed to be the real concern raised by the popular media. Like almost every news story, there was a small element of truth to it, but it was way overblown.