Recently, a friend of mine looking for a job in financial services posed the question, “I wonder how much the fiscal cliff will hurt my chances of getting a job?”  Truth be told once a deal is struck (and it will happen), all indicators point to increased hiring, not the opposite.  Still, his sentiment is one shared by millions of Americans; from Wall Street – which continues to rise and fall with varying updates on the fiscal cliff negotiations, to Washington – where talk of job killing tax-hikes have become the norm, to the public – who don’t approve of Congress or the corporate world in the slightest.

Related from Joy of Tax Law: Exaggerating the Fiscal Cliff?

This isn’t just my analysis of the economic climate; Gallup recently ran a poll of Investors and Consumers, highlighted by the following:

Investors on What’s Deterring Investment:

  • 69% agreed a divided federal government was to blame
  • 69% also agreed the scale of the federal budget deficit was of equal deterrence

Public Opinion on Going Over the Cliff:

  • 69% of Americans believe that the sequestration or spending cuts that would take place if we go over the cliff would impact the country negatively
  • 75% said the same for the across-the-board tax increases.

Public Opinion on Fiscal Cliff Negotiations:

  • 14% of Americans think  a deal is very likely
  • 44% believe it is somewhat likely
  • 39% say it is not too or not at all likely.

As you can see, my friend is not alone.  The pessimism is not without warrant, but we saw the same lack of confidence last year amidst the debt-ceiling debate – let’s be real, we were never going to default on our credit payments, just like we won’t actually fall, slide or whatever you want to call it over the cliff.   By the way, the fiscal cliff is a product of the debt-ceiling debate, read on for more on that subject. My guess is a deal happens before Christmas, because it’s no secret how much congress loves their 23 plus weeks/year of vacation time — excuse me, “non-legislative periods.”

English: Grover Norquist at a political confer...

English: Grover Norquist at a political conference in Orlando, Florida. (Photo credit: Wikipedia)

The good news is, Gallup also found that 70% of Americans think government leaders should strike a compromise, and that may happen sooner than later:  The biggest barrier to a deal is the President’s insistence on raising tax-rates for the wealthy and the GOPs staunch resistance to it.  After all, most Republicans did sign Grover Norquist‘s pledge to never raise taxes, ever, which is really coming to haunt them right now and raising questions as to which oath they are bound – the constitution’s or their own ideology (or Norquist’s).  The congressional reporting outlet Rollcall says that, “Recent public opinion polls have suggested that at least a plurality of GOP voters support tax hikes, while a majority of independents also approve.”  An offer by Speaker John A. Boehner on Friday suggests his party is giving way to public opinion, offering to let rates go up for incomes greater than $1 million, bringing the two-sides closer to a deal -— more on that later.  The Republican senate minority has also shown more willingness to compromise on this issue.

Before delving into the subject of this post, the Bush Tax Cuts, I’d like to brief readers in fiscal cliff 101, so scroll over this section if you’re familiar with the basics.

The “fiscal cliff” is a term that refers to a series of automatic spending cuts (sequestration) and expiring tax breaks that will take effect Jan. 1 2013.  Together, they total around $600 billion in deficit reduction in FY 2013 alone.  The spending cuts spread across-the-board, split evenly between domestic and defense spending, including cuts to programs such as medicare and the expiration of federal emergency unemployment insurance; the revenue side of the equation includes allowing the 2001/03 Bush tax cuts to expire for all earners as well as the payroll tax break (FICA) and child tax-credit.  This policy was mandated as part of 2011 Budget-Deficit Control Act (the one that raised the debt-ceiling) and the cliff was created as a measure of last resort if congress could not reach a deficit reduction deal before the end of 2012. The legislation set-up a Joint Select Committee on Deficit Reduction (“super committee”) to produce legislation that would decrease the deficit by at least $1.2 trillion over 10 years.  If the committee could not reach an agreement and have it signed into law, as it did, then the sequestration process go into effect at year-end.  Chairman Ben Bernanke coined the term, “fiscal cliff,” to represent the automatic spending cuts and tax-hikes that could take a huge toll on the economy if allowed to become law.

The CBO estimates that by the end 2013 unemployment would jump to 9.1%, real GDP would decline by 0.5% and the average taxpayer would be burdened with a $3,500 tax hike.  The challenge today is to create a deal before the deadline that reduces the deficit over the long-term while not hurting short-term economic growth.

(en) John Boehner and President Bush in Troy, ...

Boehner and Bush in 2004

The Bush Tax Cuts have been the spotlight of fiscal cliff negotiations.  Sure, there are plenty of other bargaining chips on the table, but none is more spoken of than what to do with the expiring 2001/03 Bush era tax cuts.  It’s not a yes/no debate, either; with President Obama winning re-election only one thing is certain – they will expire for some income earners, or no deal.  The question then is for what income thresholds, for how long, and what specific deductions should be rid of and for whom.  Amidst this negotiation is the larger question of what effect different plans will have on the economy, and the answer is something both sides use to support their arguments.

For Democrats, there is broad support for eliminating the cuts for the top 2% of income earners, as well as closing deductions and raising tax rates on capital gains.  The President’s most recent proposal outlined nearly $1 trillion in new tax revenue over ten years, $678 billion of which comes directly from allowing portions of the Bush tax cuts to expire for high income earners mainly by raising the top 2 brackets from 33% and 35% to 36% and 39.6%, respectively (CRS, Bush Tax Cuts and the Economy).  In total, Mr. Obama has lowered his demand for new revenue from $1.6 trillion to $1.4 trillion, while Republicans seem to have raised theirs from $800 billion to $1 trillion.  A compromise of $1.2 trillion, which some say is Mr. Obama’s bottom-line, may be the deal-breaker if and when Republicans can find a way to raise that much revenue, and only if they are happy with the level spending cuts in the deal.  Currently, Mr. Obama’s plan calls for $400 billion in reductions from federal healthcare programs, and an additional $200 billion from other discretionary spending.  Mr. Boehner’s plan calls for twice as much in cuts – $600 billion from healthcare and $600 billion from elsewhere.  More relevantly, the speaker’s recent offer to raise the top tax bracket for $1 million of income and above to 39.6% would only generate $300 billion/10 years – and Republicans have not specified how they account for the remaining $700 billion in new revenue they have agreed to in principle.

With regards to the Bush Tax Cuts, the debate rages on as to what effect allowing them to expire in the way the President insists would have on the economy.  Republicans maintain that his proposal would burden small businesses, stall employment and deter economic growth.  They have a point – if the cuts were extended for everyone, as they prefer, the CBO estimates that although $330 in new revenue would be forgone for FY2013, 1.8 M new jobs would be created and GDP would grow by 1.4%.  With speaker Boehner now offering to raise rates for incomes over $1 million, those numbers would be slightly smaller.  However, if they were raised for just earners making over $250,000 as Mr. Obama prefers, there would still be over 1.6 M jobs created and GDP growth of 1.3%.  This is because of what has become abundantly clear in the last decade, especially in the wake of the great recession: morality aside tax-cuts for the rich have a very small economic impact.  As the CBO put it in their analysis of cliff policy options, “extension of lower tax rates on higher incomes would have a relatively small effect on output per dollar of budgetary cost.”

Under either proposal (Obama/Boehner) the employment rate and GDP growth projections don’t change much.  Revenue, however, does change significantly.  According to the Center on Budget and Policy Priorities, raising the threshold for Bush tax cuts from $250,000 to $1 Million equates to $366 Billion — nearly half the revenue.   Given that Mr. Obama’s plan for the Bush tax cuts generates twice as much revenue with little burden on the economy, he argues some of the more popular government programs can be saved from being stripped or nixed altogether.

This data isn’t news to the GOP, and some Senate republicans have publicly stated they will except raising taxes on the top 2% in exchange for significant spending cuts, although Obama’s $600 billion offer may not be enough.  Regardless, raising taxes on anyone is as taboo as it gets for Republicans right now.  Although a heavy majority of  Americans including many Republicans would support some sort of deal that included the proposed tax hikes, some Republican legislators are sitting on their hands.  Publically, it may be politically unviable for some to support a plan that hints of raising taxes – many of them were elected to office on a promise that they wouldn’t, but the pressure is mounting.  Some corporate groups are even siding with Obama on the Bush tax cut issue as well:  Business Roundtable – an influential lobbying group composed of prominent CEOs who represent over $7.3 trillion in revenue said in a letter to Congress that Republicans should concede on tax-hikes for the wealthy if that meant cutting entitlements and setting a path towards corporate tax reform.

This brings me to the title of this article – A Republican Civil War.  The president’s demand to raise taxes led one Republican lawmaker to call it, “a brilliant play to start a Republican civil war.”  With the Republicans already struggling with internal divisions, Mr. Obama, whether intentionally or not, is asking Republicans to get on-board with a plan that could seriously sharpen them.  Regardless of what makes sense, the GOP has built itself on an anti-tax stance, especially in recent years.  Republicans who get on board with a deficit reduction deal that includes raising taxes, even to a small extent, are taking a major political gamble.  Mr Boehner has already started down this track, and he has a lot of work to do convincing his colleagues and constituents that concession on taxes for the wealthy is a political reality, and maybe, just maybe what’s best for the country.

With only a week before Christmas, expect negotiations to intensify day-by-day.  Oh, and if you’re a little overwhelmed by all the numbers in this post, stay tuned for an infographic that lays the data and proposals out in a simpler, more visually appealing manner.

Happy Holidays everyone, and let’s hope that we can celebrate New Years Eve without being tempted to turn to C-span.

JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.