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November 28, 2012

SCHANSBERG: Path to ‘fiscal cliff’ lined with debt, deals and political procrastination

Before President Obama’s second term, he has some crucial business with the “lame-duck” session of Congress. Because of temporary tax cuts, previous budget deals and procrastination in dealing with the debt, the country now faces a “fiscal cliff” on New Years Day 2013.

The key factors are the Budget Control Act of 2011 and the scheduled end of a handful of tax cuts. The BCA lays out automatic budget cuts to be split between military and domestic spending: $55 billion in both categories. This would result in a 9 percent cut to the Pentagon and an 8 percent cut in domestic programs — but only when compared with their regularly scheduled increases.

The tax increases would be much larger: about $500 billion overall or what the Urban Institute’s Tax Policy Center estimates to be $3,500 per household on average and $2,000 for “middle income” households.

About $156 billion of this is the expiration of the Bush-Obama income tax cuts. Marginal tax rates would increase across the board — from 10 to 15 percent on the lowest end and 35 to 39.6 percent on the highest end. The child tax credit would be reduced from $1,000 to $500 per child and would no longer be refundable.

As for the tax cuts on those earning more than $250,000, their expiration would raise about $23 billion. Higher tax rates for all capital gains and dividends would raise about $25 billion. The estate tax — currently 35 percent on wealth over $5.12 million — would revert to 55 percent on wealth over $1 million, raising about $10 billion.

There are four other significant tax increases on the horizon. First, “accelerated depreciation” would end — a subsidy to business which artificially boosts the attractiveness of capital.

Second, Congress will consider another Band-Aid for the “alternative minimum tax” — an arbitrary limit on loopholes. If not, the alternative minimum tax would expand from five million to 25 million households, raising their taxes by $3,700 on average.

Third, Obamacare will add new taxes of $23 billion, mostly from a payroll tax increase on high incomes. Fourth, Obama’s “payroll tax holiday” will expire, increasing taxes by $125 billion on all workers.

The problem is that we have massive deficits and debt. The White House estimates that revenues will cover only interest on the debt and “entitlement” spending in 2012. All other functions of government are being financed through borrowing.

It’s doubtful that enough of our elected officials have the courage to cut spending, so the rich are an attractive target. Politically, the GOP may be better off to join the president here. It wouldn’t raise much money, but it would show willingness to compromise and remove a big distraction.

Then, we can focus on the critical choice: big spending cuts versus big middle-income tax increases to close the budget chasm caused by our elected officials.

— D. Eric Schansberg, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a professor of economics at Indiana University at New Albany.

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