WASHINGTON – If you think this debate about the “fiscal cliff” is some abstract policy fight that won’t affect you, or if you think you won’t notice any pain from it until you do your 2013 tax returns in early 2014, you need to think again.
In fact, if Congress and the president don’t agree on a budget deal by the end of the year, you will almost certainly start to feel the pinch in your paycheck come January.
Depending on your income level and family status, the amount the Internal Revenue Service takes out of your paycheck will rise, on an annual basis, anywhere from a few hundred dollars to a few thousand. Blame it largely on the end of a payroll tax holiday enacted two years ago.
Beyond that, a sudden hike in the Alternative Minimum Tax could wipe out the refunds of many middle-income residents in the Buffalo area when they pay their 2012 taxes next April, a full year before the repeal of the Bush-era tax cuts would take full effect.
Add it all up, and the overall tax increase for the typical New York State family in 2013 would be a whopping $4,103, according to the Tax Foundation, a Washington think tank.
The increase for most Buffalo families would be less than that, given that the median household income in the region trails the statewide average.
Still, many money experts fear what will happen if a stalemate between Democrats and Republicans results in a national tumble off the fiscal cliff.
“This is a manufactured crisis, and the expectation is that either something gets done prior to Dec. 31 or we will go over the cliff and everybody’s taxes will go up,” said Anthony J. Ogorek, a financial planner in Amherst.
Budget hawks in Washington are worried, too, despite some signs among Republicans of a movement toward the key Democratic demand of higher taxes on the wealthy.
“I believe the probability is that we’re going over the cliff,” Erskine B. Bowles, a Democratic deficit hawk who co-chaired a commission that proposed a wide-ranging budget reform plan two years ago, told reporters Wednesday. “And I think that would be horrible. I think it would be devastating to the economy.”
In particular, it would be devastating to taxpayers – and not just because tax cuts enacted under President George W. Bush are set to expire.
In fact, there’s much else that would hit taxpayers a lot sooner – and potentially harder.
First and foremost, payroll taxes – which go to fund Social Security and Medicare – would automatically rise to 6.2 percent, from 4.2 percent.
That increase would be the main reason why, come the new year, the IRS would start withholding more for taxes from virtually everyone’s paycheck.
“It would reduce disposable income and dampen consumption,” said George M. Palumbo, a Canisius College economics professor. “That’s an immediate pinch.”
In other words, starting in January everyone would have less to spend – and that, of course, could hurt everyone from retailers to bars and restaurants to automakers that have plants in Hamburg and the Town of Tonawanda.
How much less you would have to spend depends on how much you make and whether you have a family.
For a single person earning $25,000 a year, the monthly hit would be about $78, according to www.paycheckcity.com, which helps businesses figure out their tax withholding. For a family of four with an income of $75,000, monthly take-home pay would shrink by $197.50.
“It will have a very negative impact on a lot of our clients,” said Paul C. Atkinson, president and CEO of the Consumer Credit Counseling Service of Buffalo. “These are people who are doing the right thing and putting together a budget and trying to put themselves in a better place financially, but they don’t have a lot of wiggle room. And, all of a sudden, they are going to be back to square one again.”
And as if shrinking paychecks were not bad enough, the fiscal cliff could deliver another gigantic hit to many middle-income families when they sit down to do their 2012 taxes.
That’s because Congress never “patched” the Alternative Minimum Tax to make it comport with modern-day finances for the 2012 tax year.
As a result, many families will see their 2012 tax bills rise by an average of $3,700, the Tax Policy Center said.
Given that the average refund last year was $2,913, the AMT hike could mean that millions of taxpayers who are expecting a refund will end up owing the IRS money instead.
“That could affect a lot of local taxpayers,” said Richard K. Schroeder, a financial planner in Amherst.
The Congress that created the AMT didn’t index it to inflation, so unless Congress now enacts an annual “patch,” plenty of people who would have been higher-income in 1969 but who are middle-income today get thrown into an alternative tax universe where many deductions don’t count and people have to pay a flat tax rate of either 26 or 28 percent.
For 2011, single filers making more than $48,450 and married taxpayers who made more than $74,450 had to subject themselves to the AMT test to see which amount they owed. But if Congress does nothing, those thresholds will plummet to $33,750 for single filers and $45,000 for families in the 2012 filing season. At these levels, about 33 million taxpayers would pay the AMT for tax year 2012 – up from a mere 5 million if a patch were enacted, Steven T. Miller, acting IRS commissioner, said in a letter to Congress.
That being the case, many tax experts expect Congress to at least pass an AMT patch, even if it can’t deal completely with the fiscal cliff before Dec. 31.
“The consequences of doing nothing are so unbelievably dramatic that I can’t imagine them not doing something,” said Nick Kasprak, an analyst with the Tax Foundation.
Then again, the consequences of letting the Bush tax breaks expire are pretty dramatic, too. Starting in the 2013 tax year, tax rates would increase not just for the rich, but for almost everybody. The poorest taxpayers, those in the 10 percent tax bracket, would have to pay 15 percent. Most middle-income tax rates would rise. In fact, the only people who could expect little change would be those in the 15 percent tax bracket.
What’s more, maximum capital gains rates would rise from 15 percent to 23.8 percent. The maximum tax on dividends would rise from 15 percent to 43.4 percent. The child tax credit would shrink by half, to $500. And the estate tax exemption would plummet to $1 million, down from $5.12 million today, while rates would rise from 35 percent to 55 percent.
As tax hikes loom, Schroeder advises clients to cash in stocks now if they’re holding them for sentimental reasons, adding that some clients are rushing to settle estates before Dec. 31. “If they have an opportunity to max out on something this year, they really should,” he said.
Until recently, those in Washington seemed to be maxing out only on rhetoric. But Wednesday, they offered some hope that Congress would steer clear of the fiscal cliff.
For one thing, an influential House Republican, Rep. Tom Cole of Oklahoma, said Republicans should agree with President Obama’s insistence that tax rates rise for families making more than $250,000.
“If we don’t believe taxes should go up on anybody, why can’t we accept a deal that takes 98 percent out and still leaves us free to fight on the other grounds,” Cole told the Associated Press. “I’m not for using the American people for leverage or as a hostage.”
Meanwhile, Obama said he was confident that he and Republicans could strike a deal.
“I am ready and able and willing and excited to go ahead and get this issue resolved in bipartisan fashion,” Obama said, “so that American families, American businesses have some certainty going into next year.”
How pay would be affected
For single filers: (Listing annual income, then change in annual income due to greater withholding):