'Fiscal cliff': Understanding the basics of the looming federal budget crisis

WASHINGTON - Plenty of ink has been spilled in reporting on the so-called "fiscal cliff," despite indications that what the dramatic coinage refers to is not well understood by most Americans. We asked experts in federal budgeting to clarify what it is, what it isn't and what falling off it might mean.

Q: What is the fiscal cliff?

A: It's not a cliff so much as a series of economy-harming bombs -- involving higher taxes and broad, automatic cuts in government spending -- timed to go off at the end of the year.

For context, we need a short history lesson. In August 2011, Congress passed and the president signed the Budget Control Act, resolving the debt-limit crisis that had threatened to cause a first-ever U.S. default. The legislation included setting up a congressional Joint Select Committee on Deficit Reduction, or "supercommittee," tasked with cutting $1.5 trillion in spending over the next 10 years.

The law also specified that unless the supercommittee found at least $1.2 trillion in cuts by Dec. 31, 2011, huge automatic spending reductions -- called sequestration -- would kick in beginning in 2013. Without those cuts, the law also blocks extension of the Bush tax cuts and the 2 percent payroll tax holiday set to expire at the end of 2012; previous, higher rates will kick in.

There is some debate over who coined the term "fiscal cliff" historically, but Federal Reserve Chairman Ben Bernanke first described the pending year-end fiscal crisis as "a massive fiscal cliff" at a hearing last February.

Q: What happens to personal income tax rates if Congress doesn't avert the cliff?

A: Tax rates will go up for everyone. Those now in the 25 percent tax bracket --including married people filing jointly, with incomes between roughly $70,000 and $142,000 -- will see their rates rise to 28 percent. Those now at 28 percent --including joint filers with incomes up to $217,000 -- will see theirs rise to 31 percent. Those at 33 percent --currently joint filers with incomes up to $388,000 -- will move to 36 percent. Those at the current top rate of 35 percent -- joint filers with incomes over $388,000 -- will pay 39.6 percent.

In addition, the top rate for capital gains will rise from 15 to 20 percent. Dividends, which have been treated as capital gains, instead will count as ordinary income.

The Tax Policy Center -- a joint project of the Urban Institute and Brookings Institution, both Washington think tanks -- calculated how missing the deadline would affect various households at various income levels if nothing happens before Dec. 31. Some examples if no deal is reached: An unmarried couple with no children making $57,462 in 2012 would pay $1,200 more. A married couple filing jointly with two children under 13 and making $75,240 would pay an additional $2,892.

Q: How would going off the cliff affect the economy as a whole?

A: Most analysts agree with the Tax Foundation, a nonpartisan Washington-based tax policy think tank. It concluded the higher tax provisions "would seriously depress economic activity," its website says. The automatic $109 billion in federal spending reductions in the first year likely would have a damaging effect.

Q: What role do Social Security and Medicare play in averting the year-end fiscal crisis?

A: While entitlement spending and an aging population suggest a future of higher taxes or significant federal spending cuts, or both, there is no reason for adjustments in Social Security or Medicare benefits before 2012 ends. Republicans would like to add future adjustments to the discussions, just as President Barack Obama would like to add a deal for automatically increasing the debt ceiling before another crisis, but those issues are separate from the hard deadlines imposed by the Budget Control Act.

Q: How would the sequestration of federal spending be conducted in the new year?

A: The 2011 law calls for across-the-board cuts of 8.4 percent for many non-defense discretionary spending programs; 8 percent for several mandatory programs except for Medicare; 7.5 percent for select defense programs; and 2 percent cuts to Medicare providers.

The Center on Budget and Policy Priorities, a Washington think tank that examines tax and spending policies with an eye on their effects on the poor and middle class, notes that non-defense discretionary spending pays for education, national parks, the FBI, the Environmental Protection Agency, low-income housing assistance and medical research, among other things. The center notes that the largest cuts to mandatory spending -- besides the $11 billon reduction in payments to Medicare providers next year -- would affect farm subsidies and student loans. Some mandatory programs exempt from sequestration include Social Security, Medicaid, the Children's Health Insurance Program, food stamps, veterans' benefits and Supplemental Security Income.

Most Republicans acknowledge sequestration was never a good idea and are eager to avoid the cliff, with

some saying a major concern is that proposed defense cuts could ultimately weaken national security.

Q: Who are the negotiators and what proposals are getting the most attention?

A: The main negotiators are Obama and Republican House Speaker John Boehner and their respective chiefs of staff, Jacob J. Lew and Mike Sommers. Democratic Senate Majority Leader Harry Reid is also playing a leading role.

Negotiations seem headed toward House passage of a bill, already passed in the Senate, that would extend the Bush-era tax cuts to households making less than $250,000. The president has insisted and campaigned on a rise in the marginal income tax rate for the highest earners, with polls showing solid support for his position. A consensus appears to be congealing around raising it to 37 percent, rather than returning to the 39.6 percent of the 1990s. In exchange for effectively ending their no-tax-increase pledge, Republicans want to talk entitlements and specifically a demand to raise the age for Medicare eligibility.

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