Questions and answers about the US 'fiscal cliff'

Friday, December 7, 2012, Vol. 36, No. 49

WASHINGTON (AP) — Congress and the White House are struggling to avoid the "fiscal cliff," the package of huge tax increases and spending cuts that kick in next year unless a budget agreement is reached first.

Going over the cliff would raise most Americans' taxes and could damage an already-weak economy. The nonpartisan Congressional Budget Office says leaving the tax increases and spending cuts in pace for a year would push the economy into recession in the first half of 2013.

Still, if the economy goes over the cliff for a month or two, rather than a full year, growth would slow, but a recession would probably be avoided.

Here are some questions and answers about the cliff:

Q: What's in the fiscal cliff?

A: About four-fifths of it involves tax increases. Income tax cuts that took effect in 2001 and 2003, and tax credits in a 2009 economic stimulus package, expire Jan. 1. A cut of 2 percentage points in the Social Security tax rate will also end. And spending would be slashed sharply and broadly. Defense spending would plunge nearly 10 percent. Layoffs by defense contractors would likely follow. Other domestic spending would be cut about 8 percent. If carried out for all of 2013, the tax increases and spending cuts would cost the economy about $670 billion, the CBO estimates.

Q: Will my taxes go up?

A: Probably. Roughly 90 percent of households would pay more. Middle income households would pay, on average, about $2,000 more, according to the nonpartisan Tax Policy Center. The top 20 percent would owe an average of about $14,000 more. Even if Congress delays or blocks the income tax increases, the Social Security tax cut is set to expire. Nearly everyone who gets a paycheck would receive less take-home pay. This change would cost someone making $50,000 about $1,000 a year, or nearly $20 a week. A household with two high-paid workers up to $4,500, or nearly $87 a week.

Q: How did we end up with this mess?

A: President Barack Obama and Congress sought to boost the economy by extending or adopting many tax cuts and credits in 2009 and 2010. Most of those measures are set to expire at year's end. And in August 2011, Congress agreed that deep across-the-board spending cuts would kick in if a budget agreement wasn't reached by New Year's 2013.

Q: How bad would it be to go over the cliff?

A: It depends how long it lasts. If negotiations continue for a few weeks past Jan. 1 and a deal is in sight, it probably wouldn't slow the economy much. Few Americans would expect the tax hikes and spending cuts to last. And the cuts could be repealed retroactively. The Treasury secretary could even instruct the IRS to delay increased income-tax withholding if a deal was in sight. But if the negotiations collapse and the measures take effect permanently, it could be painful. The stock market would likely plunge. Consumers would probably cut spending. Anticipating fewer customers, retailers, restaurants, hotels, auto makers and many other companies could cut jobs. And defense contractors and other companies hurt by the drop in government spending would lay off workers. If the tax hikes and spending cuts remained in place for a full year, the CBO forecasts that the economy would shrink 0.5 percent in 2013.

Q. When would most people begin to feel the effects from going over the cliff?

A. For most Americans, the tax hit would be modest at first. The expiration of Social Security and income tax cuts would be spread throughout 2013. For taxpayers with incomes from $40,000 to $65,000, paychecks would shrink an average of about $130 in January, according to the nonpartisan Tax Policy Center.

Q. With the budget deficit topping $1 trillion, shouldn't we welcome spending cuts and tax increases to reduce the red ink?

A. Most economists favor reducing the deficit. But they'd prefer to phase in spending cuts and tax increases slowly, particularly because the economy is still recovering from the Great Recession. The tax increases would be the largest tax increases in 60 years as a percentage of the economy. And most budget experts think spending cuts should be targeted and include entitlement programs such as Medicare and Social Security, rather than indiscriminate across-the-board cuts.