If Congress Goes Over the Fiscal Cliff Your Taxes Will Likely Go Up

If Congressional gridlock sends the U.S. government tumbling over the fiscal cliff later this year, Americans could face an average tax hike of almost $3,500 in 2013. Nearly 9 of every 10 households would pay higher taxes. Every income group would see their taxes rise by at least 3.5 percent, but high-income households would suffer the biggest hit by far, according to a new Tax Policy Center analysis.

TPC found that if the tax hikes last the entire year—a big “if”–those in the top 0.1 percent would pay an average $633,000 more than if today’s tax rules were extended. However, even middle income households would take a hit: they’d pay an average of almost $2,000 more, and see their after-tax income fall by more than 4 percent. Such tax hikes would be “unprecedented,” said the paper’s authors, Bob Williams, Eric Toder, Donald Marron, and Hang Nguyen.

What’s scary, of course, is that all this would happen automatically. It would merely require Congress to default to its normal state of partisan gridlock in the face of a remarkable confluence of circumstances. They include the reversion of nearly the entire tax code to what it was at the end of the Clinton Administration, new taxes to pay for the 2010 health reform law, and automatic across-the-board spending cuts that would trim just about every government program except for Medicaid and Social Security. Looming in the background: The Treasury will hit its borrowing limit sometime in the first quarter of next year and temporary funding to keep the government operating will end in March.

Taxes would rise by a half-a trillion dollars in 2013. On top of the substantial spending cuts, such an austerity budget would sharply reduce the deficit. But it also is likely to throw the still-weak economy back into recession. The Congressional Budget Office predicts that if the tax hikes and spending cuts last the entire year, the 2013 economy would contract by 0.5 percent and employment would fall by 2 million.

The tax increases would hit nearly everyone, and from all directions. The tax cuts enacted in 2001, 2003, 2009, and 2010 would expire. More than 120 million households would lose the benefits of the two-year-old payroll tax cut. Low-income working households would suffer as the Earned Income Tax Credit and the Child Tax Credit are scaled back. Upper middle-income households would lose their protection from the Alternative Minimum Tax and pay higher rates. Those at the very top would not only see rates on their ordinary income rise, but they’d also face higher taxes on their capital gains and dividend income as well as their estates.

At the same time, those high-income households will pay an extra 0.9 percent Medicare payroll tax and a new 3.8 percent tax on investment income—both included in the 2010 health law.

This mess was created by the temporary debt limit deal Congress and President Obama reached in the summer of 2011. The whole idea was to design draconian tax hikes and deep spending cuts that no one could stomach. As a result, lawmakers would come to their senses and replace the cliff with a steady and predictable glide path to fiscal responsibility. That’s not what happened.

Now what? Congress could, to stretch the metaphor, tumble over the cliff, fighting and clawing all the way to the bottom, and leaving itself–and the U.S. economy–woozy and bruised. That’s the outcome TPC has analyzed.

But there are other possibilities. Public anger and market fear could drive politicians to finally do the budget deal they’ve been avoiding for more than a decade–perhaps early next year. In that case, short-term tax increases might be fairly modest, though any long-term agreement is also likely to include higher taxes for many. Or, lawmakers could get to precipice, peer over the edge, and delay the day of reckoning into later in 2013.

If you want to learn more about the fiscal cliff and its consequences, I’ll be moderating a panel discussion at The Urban Institute on Tuesday, Oct 2 at Noon. You can watch in person or on the Web.