An analysis by the Tax Policy Center gives us a good idea of which American households will be hit the hardest by the expiry of nearly every tax cut enacted since 2001. Almost 90 percent of Americans would see their tax burden rise if Congress and the President can't come to some sort of agreement that solves the issues that will arise on January 1, 2013. On the upside, provided that politicians show some degree of prudence, these changes will have the positive effect of reducing America's sovereign debt growth rate and debt-to-GDP ratio. Federal tax collection in 2013 would rise by more than $536 billion in 2013, up 21 percent from their status quo level if all tax provisions were extended.
Here is a summary of the expiring Bush-era tax provisions:
Here is a summary of the expiring Obama-era tax provisions:
If all of the tax increases scheduled for January 1, 2013 and if the Alternative Minimum Tax patch is not extended through 2013, the average federal tax rated including individual, payroll and corporate taxes would increase from 19 percent to 24.3 percent. The average tax burden would increase by $3,500, roughly 5 percent of pretax income. On average, after-tax income would drop by 6.2 percent.
Here is a table showing how each income quintile (each one-fifth grouping of taxpayers by cash income) will be affected by the fiscal cliff:
Middle income Americans will see their average federal tax rate rise by 3.8 percentage points, costing them an additional $1,984 in federal taxes in 2013. The top 20 percent of earners will see their federal tax rate rise by 5.8 percentage points, costing them an additional $14,173 in federal taxes in 2013. The much ballyhooed one percenters (all 1,147,000 of them) will see their tax burden rise by 7.2 percentage points, costing them an additional $120,537 in federal taxes in 2013.
Here is a bar graph showing the average federal tax rate by cash income percentile for 2013 under both scenarios:
Note that the average effective marginal tax rate for all American taxpayers will rise by 4.9 percentage points on wages, salaries and by 5.1 percentage points on interest income. Rates for capital gains will rise by 7.2 percentage points and for qualified dividends, rates will rise by 20.3 percentage points on average. As shown here, these changes vary widely depending on the level of cash income:
Again, the top one percent of American earners will see the rates on capital gains rise by a hefty 8.1 percentage points (compared to an average of 7.2 percentage points for all cash income groups) to 22.7 percent with the rates on dividends rising by 25.8 percentage points to 41.1 percent. Tax rate increases for lower income Americans on these three sources of income are not as substantial, however, lower income Americans generally have very little income from capital gains and dividends so the point is rather moot.
When all of this is said and done, if Congress and the President are unable (or unwilling) to achieve a compromise on the expiring tax provisions, it is Washington that will benefit, at least until the economy slows. Here is a table showing the estimated increase in federal tax revenues by type for 2013:
Notice that the lion's share of the problem will fall on workers who will see their paycheques drop by $115 billion as the two percentage point payroll tax cut expires; this expiry will affect 77 percent of all households. Americans who work for a living will bear at least 21 percent of the 2013 increased tax burden based on increases in payroll taxes alone. The top 60 percent of American taxpayers will see their taxes increase with only one-third of taxpayers in the bottom 20 percent of earners seeing their taxes drop.
Perhaps it's just me, but there may be a reason why a deal in Washington is proving so elusive. Could it be that Washington is just as happy to let everyday working Americans bear the burden of reducing the deficit and controlling debt growth since those that sit in Congress seem incapable of reining in spending? After all, if the tax provisions expire, it is practically a certainty that the federal government will see their revenues rise by over 20 percent while the spectre of a related recession is less somewhat less certain. Maybe the President and John Boehner are willing to roll the dice and take their chances.