Late Tuesday night, the House of Representatives concurred with the Senate on passage of a plan that averts most of the policy changes that have come to be known as the “fiscal cliff.”
What exactly does this all mean? The Tax Foundation did post a pretty comprehensive rundown of the plan components on Tuesday. Here is what the plan includes:
- Retains the 10 percent, 15 percent, 25 percent, and 28 percent income tax brackets from the Bush tax cuts permanently
- Retains the 33 percent and 35 percent income tax brackets from the Bush tax cuts for taxable income under $400,000 (single), $425,000 (head of household), and $450,000 (joint filers). Imposes 39.6 percent tax rate on income above this level.
- Phases out personal exemptions (PEP) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers)
- Limits itemized deductions (Pease) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers)
- Capital gains tax and dividends tax will be 20 percent for taxpayers with income over $400,000 (single) and $450,000 (joint filers). This does not include the new 3.8 percent health care tax on investment income above $200,000 (single) and $250,000 (joint filers) in adjusted gross income, so the top rate for capital gains and dividends will be 23.8 percent. For lower income levels, the tax will be 0 percent, 15 percent, or 18.8 percent.
- Continues setting the standard deduction for joint filers at 2 times single filers (would have otherwise reverted to 1.67 times single filers)
- Permanently sets Alternative Minimum Tax (AMT) exemption at $50,600 (single) and $78,750 (joint filers) for 2012 and adjusts for inflation thereafter
- One year extension of 50 percent bonus depreciation rules
- Extends American Opportunity Tax Credit (education) through 2017
- Extends the various “extenders” tax incentives through 2013
- Retains the doubled child tax credit ($1,000) permanently, its refundable portion through 2017, and the expanded earned income tax credit (EITC) through 2017
- Raises estate and gift tax to 40 percent, but above the current exemption level (~$5.12 million) and adjusted for inflation in future years
- Extends emergency unemployment compensation (EUC) and extended benefits (EB) unemployment insurance program through January 1, 2014
- One year “doc fix” for Medicare payment physicians
- Extends existing agricultural programs for one year (preventing the “dairy cliff”)
- Postpones sequester by two months; will now occur on March 1, 2013
- Permits 401(k) plan participants to convert their plan to a Roth plan, under which contributions are taxed going in but withdrawals are tax-free. The result is a short-term revenue boost now and more tax-free savings accounts.
- Ends 2 percent payroll tax cut; taxpayers should expect greater FICA withholding from their next paycheck.
- No action on the debt ceiling. The U.S. hit the debt ceiling on New Year’s Eve, although Treasury actions to juggle books and defer payments will forestall default until late February. Biden has reportedly pledged to liberal Democrats that the President will not negotiate over the debt ceiling.
Naturally, extensions and permanent implementation of various tax and spending policies has an impact on current and future projections of the Federal Budget. The CBO analysis issued on Tuesday showed that the policy changes, compared to the policy changes that took effect on January 1st, would increase the Federal deficit by $3.9 Trillion over the next 10 years. Compared to policy prior to January 1st, however, the plan raises $620 Billion in taxes over 10 years.
Click Here for CBO Analysis
There is differences over projections on spending. The CBO estimates the bill increases spending by $57 billion over 10 years, while Congress’ Joint Committee on Taxation estimated the plan cuts spending for the same period by $15 billion. At best, the plan only cuts $1 in spending for every $41 in new taxes.
The lack of spending cuts is good news for economic interests depending on Federal spending. Prior to the New Year, stock markets lost some value as concern about the lack of a deal grew. However, following House passage of the plan Tuesday night, global markets rebounded, and the Dow Jones in the U.S. is expected to have a strong day Wednesday following strong performance in futures overnight.
As for taxpayers, the expiration of the temporary reduction in payroll taxes will means increases for more than just those in the top marginal bracket. Tax Policy Center estimates that 77% of households will see a tax increase in 2013. The average tax increase as a result of the end of the payroll tax reduction is projected to be $740 per worker.
The deal also included a two-month reprieve on “sequestration” cuts, which would have resulted in significant spending reductions. The new Congress, taking office Thursday afternoon, will have to work to address sequestration, as well as likely extension of the debt limit, which was reached prior to the end of 2012, creating a situation for potential default on Federal debt if not increased by the end of February.
Here is a historic look of important Federal tax rates, courtesy Tax Foundation: