What Will the Fiscal Cliff Mean for You and Me?
In a recent article for the National Journal, Sophie Quinton reviewed what some of the issues would look like for us relative to the automatic implementation of some Bush era taxes and sequestration (I know, just another “economist and congressional term for biting us in our wallets again!)

According to Ms. Quinton the fiscal cliff isn’t just about taxes. She notes that for the average American, higher taxes will be the most salient impact if Congress allows spending cuts and tax increases to kick in with the new year. Economic analysts anticipate that the economy will take a hit if the country goes over the fiscal cliff, which could mean shaky financial markets and another recession. That hit will affect everyone.

How much of a tax hike an individual will see will depend on marital status, number of dependent children, number of deductions typically claimed, and the taxpayer's mix of wage and investment income. With that in mind, she provides us with a primer on what’s beyond the cliff and what it could mean for certain groups. Below is some more of her article which you can find in the National Journal.


What’s in the cliff?

There are three basic components of the fiscal cliff: expiring Bush-era tax cuts, expiring Obama-era tax cuts, and spending cuts to some federal programs.

The expiration of the Bush-era tax changes would mean higher income taxes, reduced tax benefits for families with children, increased marriage penalties, a higher estate tax, and higher taxes on some investment income. The most pressing Obama-era tax hike would be the expiration of the payroll-tax cut. The payroll-tax cut was always meant to be temporary, but a return to higher Social Security payments would mean less money in everyone’s paychecks.

Other Obama-era tax cuts included in the stimulus package are also expiring, including tax credits for families with children and a credit to help students pay for college. Higher earners would see an additional bump in their income and capital-gains taxes next year because of new taxes included in the 2010 health care. And then there’s the alternative minimum tax, a cumbersome income tax that has to be periodically adjusted to track inflation. If Congress doesn’t do so this year, it could hit individuals making as little as $33,750, raising taxes on millions of Americans.

Spending cuts are the final component. Certain domestic federal programs—but not Medicare or Medicaid—would see reduced funding as a result of spending cuts known as "sequestration." Funding for unemployment insurance is scheduled to drop, as are Medicare payments to doctors.


How the Fiscal Cliff Will Affect You

According to Bruce Watson, writing for the Daily Finance, to get an idea of how the fiscal cliff will affect the average American family, it helps to understand exactly what that family looks like. According to the Census Bureau, the median American household has 2.6 people and brings home just under $50,000. With the expiration of the Bush tax cuts, the first thing that will hit this family is an immediate, steep increase in the amount that it sends to the IRS.

After the standard deduction, the average family currently pays 10% of its income up to $17,400 and 15% of all income between $17,401 and $70,700. For a family making $50,000, this works out to $4,845 in base taxes. If we revert to pre-Bush rates in 2013, the average family will pay 15% taxes on all its income. For a middle class family, this works out to a tax bill of $6,397, a jump of $1,552.

If our hypothetical family has a child in college, it will feel the pinch even more. Currently, families that make $100,000 or less can claim the American Opportunity Tax Credit, which allows them to deduct up to $2,500 in school expenditures for every student for up to four years. On Jan. 1, that benefit expires, and the less-generous Hope credit is all that's left to take its place. Under Hope, families making less than $100,000 can claim $1,800 per child for up to two years.

In other words, a middle class family with a child in college can expect to get $700 less in deductions immediately, and $6,400 less in deductions over the course of their child's education.

It gets worse: the "payroll tax holiday," a 2% Social Security tax cut on the first $110,000 in wages, is set to end. For the average family, this will mean a tax hike of $1,000 per year. At the same time, the average middle class family will also get hit with the expiration of the "marriage penalty reduction," a break that was included in the Bush tax cuts. Basically, this cut enabled low- to middle-income couples filing together to pay less in taxes than they'd pay if they filed separately. With its expiration, couples will face an increase in taxes if they choose to file jointly.

If your child just graduated from college and is making $30,000 a year at an entry-level job. He and folks like him could see their tax burden rise by around $1,200 this year, according to the Tax Policy Center — a jolt that your graduate, already stressed about his student-loan payments, is unprepared for. Additionally he is also wondering if sequestration will make it harder for him to afford graduate school. While Pell Grants are exempt from automatic spending cuts, other federal programs that help students pay for college—like federal work-study programs—are not.

Lastly, as Reverend Al Sharpton says, “Its not about Obama, its about yo Mama”! Grandma’s nursing-home bills have already burned through her savings, making her now reliant on both Medicare and Medicaid funding for her care. Grandma doesn’t draw a paycheck, her income is very low, and she has few investments, so the fiscal cliff isn’t going to have a big impact on her personal finances. Grandma’s actually more worried about a deal that would avert the cliff, because that could mean cuts to the entitlement programs she depends on.

The Tax Policy Center has a handy tax calculator that allows you to figure out what the fiscal cliff could mean for your family situation and mix of assets—or just to play around with various scenarios. As the old saying goes, we are up the creek without a paddle!
 

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