By now everyone has heard of the tax increases and spending cuts that will take effect in 2013 under current law, not-so-affectionately-called “The Fiscal Cliff”. This post takes a look at many of the tax changes which will have a broad impact on individuals and joint filers regardless of income. While the list is not all-inclusive, it covers most of the changes that would affect individuals and couples (leaving out some of the business tax impacts). Some of these may come as a surprise since they don’t get much attention in the press. The chart below shows the changes as they are currently on the books, the impact of each change if left as is, and the probable outcome of efforts to avoid the Fiscal Cliff.
The probable outcomes on the changes above are not likely to close the deficit enough to prevent another rating downgrade of U.S. debt, especially if the proposed spending cuts are also scaled back to avert the fiscal cliff. To close the deficit, a broader “grand bargain” will be necessary to cut spending on entitlements and discretionary items while raising tax revenue through a major tax revamp. There is no time for this to be negotiated in late 2012 / early 2013, but I think it’s on the table toward the end of 2013 / beginning of 2014, especially if motivated by the debt rating agencies and/or market-based increases in long-term interest rates as the U.S. loses credibility as a borrower. The solution needs to be a balance of higher taxes and reduced government spending, but most of it needs to be focused on long-term changes, rather than sudden short-term shocks to the economy. I suspect this will include pushing out the SS retirement age for those currently below age 50, greater Medicare limitations and/or higher Medicare premiums for those currently below age 50 when they reach Medicare age, an increase in the SS wage base, means testing of both Social Security and Medicare (i.e. if you have high income from other sources in retirement, you’ll receive less from these programs), a slight reduction in marginal tax brackets, a large reduction in items that are excluded from income or deductible (especially for mid-high incomers), and a modified AMT that will impose a minimum effective tax rate on all income for those earning $1M or more. It’s too early to know specifics, but I’ll continue to post about these items as ideas run through Congress and become more than just speculation.