If the country flies off the fiscal cliff and almost every tax break enacted since 2001 expires, about 90 percent of all U.S. taxpayers would take a hit.
The end of the Bush-era tax cuts alone would affect 100 million Americans. The end of the payroll tax cut would affect even more — 160 million.
The financial impact on an average middle-income household would be about $2,000, the Tax Policy Center estimates. Of that, almost $700 would come from the payroll tax, and another $900 from the Bush tax cuts.
Tax experts call those increases unprecedented.
“I don’t think there’s ever been any fiscal time bomb set to go off all at once like this,” said Robert Bixby, executive director of the nonpartisan Concord Coalition.
Other taxes are affected, too. There are health care taxes, the estate tax, and the alternative minimum tax that ensures that even wealthy taxpayers pay some income tax — although in recent years the tax has affected taxpayers of more modest means. And there’s the child tax credit, and the expanded earned income tax credit for some less well-to-do families.
In all, the cuts affect some of the poorest among us as well as the richest. If they all expire, taxes would rise by more than $500 billion in 2013.
Of all the various taxes involved, members of Congress have concluded that dealing with the Bush tax cuts may be the toughest because they’re more complicated. They lowered rates for the top four tax brackets. Limitations on itemized deductions were phased out, and child tax credits were doubled. Taxes on long-term capital gains were cut.
In 2001 and 2003, when the cuts were first passed, President George W. Bush and Republican leaders of Congress believed they were permanent. But it turns out that the bill contained a 10-year sunset provision, meaning they expired at the end of 2010.
In 2008, Democrat Barack Obama campaigned for the White House on a pledge to end the cuts for high-end taxpayers, yet the Democratic Senate opted not to go there. Two years later, Obama struck a deal with Republicans to prolong the cuts through the end of 2012, along with plans to extend benefits to the long-term unemployed and a payroll tax cut for all workers.
That set the stage for what Congress faces now.
Any prospect of extending the 2 percent payroll tax cut — designed to boost consumer spending and help jump-start the economy when it was enacted two years ago — has long been considered unlikely. The cut was taken out of Social Security funds and was always intended to be short-term.
The reduction lowered the Social Security tax from 6.2 percent to 4.2 percent on the first $110,100 of income.
But some observers aren’t giving up hope. Jan Hatzius, the chief economist at Goldman Sachs, has argued for extending the cut. Letting it expire would reduce the gross domestic product by 0.6 percent next year, he estimated.
“While we agree that the U.S. government will ultimately need to tighten its belt, a big move in a restrictive direction still looks decidedly premature to us,” Hatzius said.
Others argue that even the weakened economy could absorb such a cut. They said the upward limit is 1.5 percentage points of economic output before real trouble sets in.
The GOP will push to keep the Bush tax cuts largely intact, arguing that allowing them to expire at the same time as the expected payroll tax cut would be devastating.
“Republicans want to continue them,” Bixby said. “And actually so do most Democrats, including the president, up to … $250,000 of income.”
That’s the point of contention. Republicans insist that any revenue gain from removing the cut for the richest Americans is negligible.
“It makes almost no difference, and they (Democrats) know it,” said Sen. Roy Blunt, a Missouri Republican. “It’s like one day of federal spending.”
Extending the payroll tax cut also has little support among Republicans, which may provide a rare point of agreement with Democrats.
“Crippling the Social Security system was never a good thing to do,” Blunt noted.
Rep. Kevin Yoder, a Kansas Republican, said he opposes any attempt to delay decisions on the fiscal cliff into mid-2013.
“What Americans are wanting is certainty on the tax code, certainty on spending and want to see Congress enact a long-term solution. I’m one who believes we ought to address these problems today.”
But he, too, thinks a delay is probably inevitable.
Democrats argue that the Bush tax cuts on the wealthiest Americans should expire.
“They’re saying that letting the tax cuts expire on upper income people would not have negative economic effects … because they can afford the shock better,” Bixby explained.
The payroll tax cut, however, appears to have little backing among Democrats.
“This has to be a temporary tax cut,” Treasury Secretary Timothy Geithner argued before the Senate Budget Committee this year. “I don’t see any reason to consider supporting its extension.”
The White House also has not pushed for an extension.
Paths to compromise
The outcome of the election in November will have a profound impact on the direction the debate takes. If conservative Republicans carry the day, the push for compromise could become trickier because many are committed to dramatic action on the deficit.
Some contend the big question mark remains the House. Compromise can be found in the Senate, said Democratic Sen. Claire McCaskill of Missouri.
“A lot of that depends on whether the tea party’s hand is strengthened (in the House) in November or whether it’s weakened,” she said.
“If the tea party is not as strong … then I think (House Speaker John) Boehner will want to do the right thing. I think he wants to find a compromise. But I think he’s been handcuffed by the extreme elements in his party.”
One option that some Democrats prefer is to let all the tax cuts expire, then come back in January and attempt to pass a tax cut for the middle class.
But if that strategy is pursued, it could still cause unease. “The financial markets could think it’s crazy, and it’s more gridlock and political dysfunction, and it just may tip the economy into recession,” Bixby said.
Assuming the lame-duck Congress opts for delay, one path forward could include passage of a bill that binds the next Congress to a certain level of cuts.
“Just kicking the can down the road would be a very bad thing to do,” Bixby observed.