Fiscal policy became topic number one post-election. The impending fiscal cliff has started a firestorm of speculation about the future path of federal spending and tax policy. This report sheds light on how our economic forecasts would be impacted under various scenarios of tax and spending policies. We begin with a quick summary of the options facing Congress and the president over the next few months as they work to resolve the fiscal cliff. We then present our forecast comparison should we go over the fiscal cliff and finally conclude with initial estimates on our forecast of various policy changes that could be implemented as part of a solution to the fiscal cliff.

To begin, it is important to understand what we consider part of the fiscal cliff debate compared to what we view as items considered “off the table.” First, we expect that the short-term payroll tax cut will expire next year as scheduled along with extended unemployment benefits and the accelerated, or “bonus”, deprecation on capital equipment. Because of an absence of interest in extending these three policies inside the Beltway, we do not count any of these policies as part of a fiscal cliff deal. Second, the Affordable Care Act dictates that the capital gains tax rises by 3.8 percent next year to a total rate of 18.8 percent, regardless of the outcome of the fiscal cliff debate. 1 All of these assumptions are currently built into our baseline forecast as published in our November Monthly Economic Outlook.

Included in the fiscal cliff debate are the following tax provisions as summarized by the Congressional Research Service 2:

  • Bush-era tax cuts reduced income taxes through lower across-the-board rates, reduced the marriage penalty, repealed limitations on personal exemptions and itemized deductions, expanded refundable credits, and modified education tax incentives. In addition, the Bush-era tax cuts reduced estate taxes by increasing the amount of an estate exempt from taxation and by lowering the estate tax rate.
  • The patch for the Alternative Minimum Tax, or AMT, which increased the amount of income that is exempt from the AMT, and allows certain personal credits against the AMT that prevents an estimated 26 million additional taxpayers from being subject to the AMT.
  • Tax credits and deductions (known as tax “extenders”) that affect individuals, businesses, charitable giving, energy, community development, and disaster relief.
  • In addition to the expiring tax provisions above, $1.2 trillion in automatic cuts to federal spending (known as sequestration) over the next 10 years would go into effect per the Budget Control Act of 2011. 3