Randall Explains the Fiscal Cliff

As the new year approaches, the combination of federal tax hikes and spending cuts scheduled to occur at the end of the year has the government trying to avert the so-called “fiscal cliff.” What exactly is at stake? And what kind of impact will the fiscal cliff have on the U.S. economy and your own personal finances?

Rider University’s Dr. Maury Randall, a sought-after expert on the current economic climate, recently sat down with University Communications to talk about the fiscal cliff and its implications.

What is the fiscal cliff?

Within the last 10 years, there were a number of tax benefits that had been passed and were scheduled to expire two years ago. In 2010, politicians felt pressure to delay the expiration date because the economy was weak and there was a divided government. They didn’t want to cut spending and increase taxes. We are facing the new expiration date at the end of the 2012. It’s not only tax benefits that will expire, but based on previous agreements, certain spending categories, particularly with regard to the military, are scheduled to see cuts.

What’s at stake?

The President wants wealthier people to pay more on taxes. It’s his opinion that they are not paying their fair share. However, the Republican view is that the wealthy are already paying their fair share, but they are willing to accept some changes so the wealthy will pay more. In some areas there is no disagreement among the political parties, which would both like to maintain the tax benefits for people in the middle class, and at the same time they both want to cut the deficits. Democrats want to raise tax rates and reduce some deductions available to wealthy people. The Republicans argue that many of those tax benefits go to people who own small businesses. While there are many small businesses owners, not all are wealthy. However, the wealthy small business owners produce many of the jobs in the economy. Raising taxes on that group would curtail business investment, reduce job-creation and lower overall spending in our economy. This spending decline would be bad for other companies as well.   

Taxes are currently scheduled to go up on both middle class and wealthy people. If this occurs, take-home pay is going to drop throughout the economy, and consumer spending and investment spending could drop significantly creating a recession. The labor market will be damaged again and it will become even more difficult to get a job.   

We are already seeing some impact on the stock market. Some investors, especially the more wealthy, are selling stock now with the current lower tax rate. They have a strong expectation that in the final agreement their rates will rise. Therefore, they are selling and taking profits now. That is one reason why the stock market fell during the first half of November. One last point on the stock market:  If people were really worried about the fiscal cliff, the market would not be as strong as it has been in late November and early December.

What other concerns does the fiscal cliff present?

Personal and business taxes that relate to ObamaCare (formally, the Patient Care and Affordable Care Act) and Medicare might be affected. Student loans and certain education credits might expire for some people. It depends on what your income is and how much you pay in tuition. Many businesses are already holding back spending on their plant and equipment. They are not sure what tax incentives will exist or not. The government has not been very specific about what areas of spending will be cut and to what extent they will fix Medicare and Social Security.

One particularly important item, the Social Security payroll tax cut, is scheduled to expire. The payroll tax funds the Social Security system. Under the system, workers are required to pay 6 percent, and then there’s another 1.5 percent for Medicare. Employers must match those payments and the total for employer and employee is 15 percent per worker. However, the government previously lowered the Social Security tax from 6 to 4 percent for the worker contribution. Everyone had an increase in their take-home pay due to the lower taxes, but this could change. For example, if you make $50,000, you would pay an additional $1,000 more money to go toward Social Security if those taxes rise by 2 percent (from 4 to 6 percent).  It is not clear if they will renew that or not.

Some extended unemployment benefits are due to expire. Some people who have been getting them won’t be getting them anymore. A lot is unclear. There are many different elements to the fiscal cliff, and that’s what makes it so complicated.

Can the fiscal cliff be avoided? Explain.

I don’t think that the worse-case scenarios are very likely. Look at the pattern of past years. When there were disputes in the government regarding expiration of tax cuts, spending increases or the debt ceiling, they compromised and came to an agreement. There’s a good chance they will come to a tentative agreement before the end of this year or very early in 2013. I think they are likely to restore a lot of spending that is scheduled to be cut. This is the game-playing period. As you get closer to Christmas, they will do the real bargaining. That’s my guess — by the end of the year or early in 2013, we will see more details. In any case, wealthier people will likely pay more in taxes.