The fiscal cliff isn’t just about taxes. But 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’s a shift that 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 caveat, here’s a primer on what’s beyond the cliff and what it could mean for certain groups.
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.
That’s really complicated. How would it affect people like me?
Ms. Banker. Ms. Banker lands squarely in the top 1 percent of earners: She makes $1,000,000 per year. Earners in Banker’s tax bracket are looking at a federal tax increase of around $120,000, on average, if the U.S. goes over the fiscal cliff, according to the Tax Policy Center. Banker is thinking of selling off some of her long-term investments now, in order to avoid seeing them taxed at a higher rate.
Mr. Oncologist. With an annual income of $350,000, Mr. Oncologist makes enough to support his wife and send his kids to private school. Earners in Oncologist’s bracket are looking at an average tax increase of about $14,000, according to the Tax Policy Center. Many of Oncologist’s patients are Medicare recipients, so he’s worried about the so-called "Doc Fix", the cut in payments to Medicare doctors that will go into effect next year if Congress doesn’t act. Oncologist is also unhappy about a cut to federal medical research and development spending under sequestration.
Mr. Teacher. Mr. Teacher has an income of $65,000 per year, a mortgaged home and two young children. Earners in his tax bracket should see a tax increase of about $3,500 if the fiscal cliff isn’t averted, the Tax Policy Center says. Like Oncologist, Teacher is distressed that child tax credits are going to become less generous. Teacher is also worried about how sequestration will effect education funding in his school district. He doesn’t teach in a poor area that receives a lot of federal funding, but there are kids with special needs in his classes. Teacher knows that funding that pays for aides who help those kids would be cut under sequestration.
Mr. Millennial. Mr. Millennial 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 Millennial, already stressed about his student-loan payments, is unprepared for. Millennial 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.
Ms. Grandma. Ms. 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.
You. The Tax Policy Center has a handy 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.