Sailing off the fiscal cliff makes saving more difficult

Dollar sign on cliff

As the new year began, America officially sailed off the fiscal cliff.

A combination of tax increases and government spending cuts will now take effect, at least temporarily, because Democrats and Republicans on Capitol Hill were unable to agree on a better way to reduce the federal budget deficit before the Jan. 1 deadline.

For weeks, the possibility of going over the edge has been greeted by some members of the media with more hysteria than the Mayan apocalypse forecast for a couple of weeks ago.

Now the worst has happened, and the world hasn’t come to an end.

But the cliff's severe deficit-cutting measures will make life a little tougher for all of those Americans trying to build financial security for themselves and their families.

One of the first groups to feel the impact is likely to find it the most painful. Roughly 2 million out-of-work Americans lost federal unemployment benefits at the end of December.

If Congress acts quickly in January to extend the benefits, the unemployed could receive a lump sum making up their loss (an approach Congress has taken before), but otherwise these families will feel the cost of the fiscal cliff almost immediately as assistance checks stop coming.

The effects may take a little longer to reach working Americans. Some businesses could start withholding more from paychecks on the first payday of the year. But others are likely to delay the adjustments, especially if lawmakers are still considering more changes.

Soon, however, about 90% of American households will face higher taxes if Congress doesn’t take action to reverse the new tax rates, says the Tax Policy Center, a joint effort of the Brookings Institution and Urban Institute, a pair of well-established Washington think tanks.

The impact varies widely depending on income. According to Tax Policy Center calculations:

If you’re wondering how your own income will be affected by the higher taxes, calculators are available online that can give you a good idea.

Take a look at the Tax Policy Center's calcultor (http://calculator.taxpolicycenter.org/).

Tax bills will go up because, as the Tax Policy Center states in a study, “almost every tax cut enacted since 2001” expired when we reached the cliff. These include Bush-era income tax cuts that largely benefited those in the top brackets and an Obama-era temporary cut in payroll taxes from 6.2% to 4.2%, which mostly benefited lower income taxpayers.

Capital gains taxes, inheritance taxes and a variety of tax credits also expired.

Tens of millions of Americans are also now subject to the Alternative Minimum Tax, a standard originally put in place to assure that wealthier Americans pay at least a certain share of their income in taxes.

The problem is the AMT was not indexed for inflation. In the past, Congress has regularly passed temporary, higher exemption levels to prevent less wealthy taxpayers from being swept up by the AMT, but the last such exemption expired at the end of 2012.

Overall, the Tax Policy Center estimates taxes will rise by $500 billion in 2013.

Going over the cliff also chops federal spending — roughly 8.4% of most domestic discretionary programs and a cut of 7.4% in the defense budget. Social Security, Medicare and other social insurance programs are largely exempt.

But cuts in federal spending are almost certain to take longer to be felt. Agencies already have money in the pipeline, and the White House is expected to tell administrators to delay layoffs or cutbacks if it appears there’s still any hope for a post-deadline deal.

That could happen. The cliff, it’s important to remember, is a man-made political crisis, not some inevitable natural event.

In the summer of 2011, unable to reach a deal on spending and taxes to reduce the size of the budget deficit, Democrats and Republicans in Washington decided to kick the problem down the road. But to put greater pressure on themselves, they agreed that both tax increases and spending cuts would occur if they couldn't work out an agreement by 2013.

Although the do-or-die deadline they set up has now passed, they could still cut a deal in January that reverses the effects of going off the fiscal cliff before it has time to have much impact.

The two parties had reportedly narrowed their differences on one major sticking point — at what income level tax rates should be allowed to go up — before running out of time.

It’s still possible they could at least reach a compromise on taxes that would spare most Americans from some of the scheduled hikes.

Still, you might not want to hold your breath. They gave themselves 16 months to reach an accord before reaching the fiscal cliff and couldn’t get it done.

Should that level of political dysfunction continue into the new year, and all the tax hikes and spending cuts that are part of the fiscal cliff take place, the Congressional Budget Office predicts it will send the U.S economy back into recession for the first half of 2013.

Unemployment, now about 7.7%, will climb to back around 9%, the CBO estimates. Millions more Americans will lose their jobs. Others will see their paychecks shrink.

Not the end of the world, but the political partisanship and gridlock in Washington will make it harder for all of us to save and build a more secure financial future.