There is a can being kicked down the road in Washington DC right now. It turns out the road ends on a cliff. The fear is that when the issue is finally addressed after the election that the last kick may have already put us over the edge.
The "fiscal cliff" is the term you hear thrown around on CNBC every day. It refers to both mandatory spending cuts set for 2013 that were set in place when bipartisan agreement could not be reached as well as the sun setting on the Bush tax cuts. The Obama payroll tax cut is also set to expire.
The cuts involve $1.2T over ten years. That starts with $55B in both defense and non-defense spending in 2013. That could lead to 10% cuts in all programs that are not mandatory in the military. It is estimated the other cuts could lead to 8% reductions in things such as air travel security and food inspections.
The tax cuts are a hot issue for the Democrats. The top earners would go back to paying 39.6% as opposed to 35% in income tax. The bottom bracket goes up even more from 10% to 15%. Funny, you will never hear Democrats talk about the break that was given to people not in the 1%. And it is empty rhetoric about the deficit because you could take all the income away from "the rich" and still not close the gap.
The breaks on capital gains and qualified dividends go away for 2013. Exemptions are taken away for high earners. The child tax credit is cut in half to $500. The expansion of the Earned Income Credit goes away. Changes to make the marriage penalty not sting is eliminated. And get ready for the return of double taxation with the estate tax.
Other things change as well. The Alternative Minimum Tax (AMT) rules will revert back to old rules meaning it may hit 30 payers instead of 4 million payers. Unemployment benefits will go back to 26 weeks instead of 99 weeks. The payroll tax holiday also goes away as 6.2% will be taken from a worker's paycheck instead of 4.0%.
The overall effect of the changes cost the economy about $7T.
Partisans will argue about what does and does not make sense. The truth is none of it makes sense.
The tax rates do not mean a lot. Some people who earn their income and are not living off dividends and interest my be paying close to the quoted rates. Others, like Warren Buffet, are paying the lower rates and know very well that increasing the base income rates will not affect them.
It is time to be honest about deductions. The home mortgage deduction is bowing to the special interest that is the real estate industry. It is fed by the idea that everybody should own a house which is a fallacy that helped drive the mortgage crisis.
Most deductions are put in place to help specific groups. Playing with the tax code has become one of the most useful tools for politicians to pay off special interests. It goes hand in hand with the quest to get government funding for pet projects.
Mitt Romney has been out campaigning on removing loopholes and deductions from the tax code and lowering rates. There has been criticism about details on this point. Let me help. Eliminate all of them.
If lower rates can be achieved then it is time to tax dividends and interest at the same rate. Take that Warren.
If all of this is achieved you can forget about silly things like the AMT and marriage penalty.
As for spending, it has to be noted that Medicare (23%), Social Security (20%) and Defense (19%) make up 62% of federal spending. It is impossible to not touch these programs and make a difference. It will take a leader no one has seen yet, the one willing to make the right decisions and get past the special interests.
One thing is certain. Something has to be done soon before the fiscal cliff hits. People can argue about long term policy but removing large sums of money from the economy could cause serious trouble. some projections are it could put the economy back on a negative growth curve next year.
It should be expected that there will be something passed to steer away from the cliff. Unfortunately, it will be a plan that likely keeps the special interests happy. So we make a blind turn and avoid the cliff but until we get vision the trip over the cliff remains inevitable.