Caution: Cliff Ahead

spring_roadNow that the 2012 Presidential Election is over, you’ve surely heard the next big news: “The Fiscal Cliff”. What the heck is a Fiscal Cliff? It’s a pet name that our Federal Reserve chairman, Ben Bernanke, came up with to describe a set of circumstances that are due to occur on January 1, 2013.

What is this “cliff”, anyway?

The cliff is not just one thing, it’s the combination of several things that economists assure us will send the country into another recession in the first half of 2013 if congress doesn’t make some changes during the month of December. Unfortunately, they’re really stuck in the middle here. The primary pieces of this crumbling cliff are the expiring Bush-era tax cuts, a big government spending cut, and a big Medicaid payment spending cut. All of these things have their pros and cons. Of course, the big “pro” is that letting the old tax cuts expire (I refuse to call this a “tax increase”, because that’s not really what it is at this point… it’s merely the expiration of a set of tax cuts that were intended to be temporary) brings in more tax revenue, and coupled with the reduced spending could make a dent in our federal budget deficit. This is just what our budget that everyone has been screaming about needs! Of course, the flip side is that nobody wants to be the one to pay for any of that… and in our current economy, most people can’t afford to.

The “cliff” refers to the fact that this is all scheduled to happen at the same time, and the Congressional Budget Office estimates that is will cost the Federal Government over $600 billion in 2013. So, do we stop all of these changes and accept another half-trillion dollars worth of debt and a budget that’s even further from balanced than it was last year? Or do we perhaps make some new tax cuts and ease the spending cuts in an effort to spare the economy? Tough choices, to be sure.

What is likely to happen?

We can’t say for sure what Congress will do during the month of December, but it’s not likely that they’ll risk letting our economy take another big dive if they can avoid it. The wise course of action would be some degree of compromise, however. Something between what is set to automatically happen under existing laws, and outright repeal of all of those laws.

President Obama’s desire seems to be to allow the Bush tax cuts to continue, but with an exception for those who earn over $250,000. This would allow the middle class to “keep spending”, thereby not crimping the economy, but also would provide a little more revenue to help with our budget deficit.

Another idea that has been presented both by Democrats and Republicans in one form or another is to put a cap on tax deductions. President Obama proposed capping them at 28%, and the Republicans have been flirting with a dollar-amount cap of $35,000. In either case, this would have a similar effect to limiting the tax cuts to those with income under $250,000. That is, higher income earners will pay more taxes next year.

The Take-away

All we can tell you for sure is that if you earn more than $250,000 per year, you’ll probably be paying significantly more taxes next year. And even if you earn less, you’ll probably still be paying more in some form or another, though likely not as much. We live in interesting times.

Contact Fredrick James Today to schedule a Tax Forecast that can help you prepare yourself for what lies ahead.

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