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Budget Showdown Leaves Taxpayers in Limbo Before Year End

Photographer: Andrew Harrer/Bloomberg

John Boehner, House Speaker, a Republican from Ohio, declared Obama’s last offer unacceptable because it lacked enough spending cuts and then tried to advance his own plan through the House. Close

John Boehner, House Speaker, a Republican from Ohio, declared Obama’s last offer... Read More

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Photographer: Andrew Harrer/Bloomberg

John Boehner, House Speaker, a Republican from Ohio, declared Obama’s last offer unacceptable because it lacked enough spending cuts and then tried to advance his own plan through the House.

Negotiations over a U.S. budget deal are stalled after congressional leaders headed home for the Christmas holiday without a resolution.

President Barack Obama and House Speaker John Boehner haven’t reached an agreement to avoid more than $600 billion in tax increases and spending cuts set to start taking effect in January.

Here are questions and answers about the so-called fiscal cliff and where talks stand:

Where do the negotiations stand now?

It’s not clear. Until Dec. 17, Boehner and Obama were edging closer to a deal that would have included about $1 trillion each in spending cuts and tax increases over the next decade.

Boehner, an Ohio Republican, declared Obama’s last offer unacceptable because it lacked enough spending cuts and then tried to advance his own plan through the House. The House voted 215-209 Dec. 20 to pass a bill that cut $314.5 billion in spending and delayed most of the automatic cuts.

Then, the same day, Boehner scrapped a plan to allow higher tax rates on annual income above $1 million and permanently extend the rest of the income tax cuts. He yielded to anti-tax resistance within his party, saying he didn’t have enough votes to pass the bill.

What happens next?

Photographer: Andrew Harrer/Bloomberg

Barack Obama, U.S. Close

Barack Obama, U.S.

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Photographer: Andrew Harrer/Bloomberg

Barack Obama, U.S.

Each side wants the other to act.

Boehner said the Democratic-controlled Senate and Obama should come up with a plan they can send to the House.

Senate Majority Leader Harry Reid, a Nevada Democrat, said Boehner should allow a vote on a Senate-passed bill that would extend tax rates on income of married couples up to $250,000.

Obama urged leaders of both parties to work out an interim measure to prevent taxes from rising on middle-income Americans as they work on a more comprehensive package.

Lawmakers in the Senate and House headed home for the Christmas holiday and aren’t scheduled to return until Dec. 27, with less than a week to act before the so-called fiscal cliff.

What is the fiscal cliff and who created it?

Congress and Obama did it on purpose, creating a confluence of events that were designed to put pressure on themselves to act on taxes, spending and the budget deficit.

In 2010, they extended the George W. Bush-era tax cuts for two years, meaning that breaks on income, capital gains, dividends and estates will lapse at the end of this year. In 2011, as part of a deal to raise the U.S. debt ceiling, they set up $1.2 trillion in spending cuts to occur over nine years, starting in January 2013. This year, they extended a two- percentage-point reduction in the payroll tax through Dec. 31.

What has the House passed?

The House, controlled by Republicans, passed a bill in August that would extend for one year the expiring tax cuts and begin a process for overhauling the tax code. It was silent on extending tax credits from the 2009 stimulus law for low-income families and college students. The House has also passed bills that would delay automatic spending cuts by replacing them with other cuts.

What has the Senate passed?

The Senate passed a bill in July that would extend the tax cuts for one year on income up to $200,000 for individuals and $250,000 for married couples. It also extended tax credits from the 2009 stimulus law for low-income families and college students. It was silent on the estate tax because of disagreements among Democrats, and it doesn’t address the automatic spending cuts.

What issues has neither side dealt with?

Neither the House nor the Senate has addressed the expiring payroll tax cut, dozens of lapsed miscellaneous tax breaks, expanded unemployment insurance that’s expiring or a scheduled payment cut to doctors under Medicare.

What was Obama’s latest offer?

Obama’s latest offer reduced his revenue demand to $1.2 trillion from $1.4 trillion, made a concession on future Social Security benefit increases and spared households with between $250,000 and $400,000 in annual income from tax-rate increases.

What has changed in the talks over setting higher tax rates?

This month, Boehner offered to raise taxes for the first time, marking the threshold for higher rates at those earning more than $1 million. Obama’s latest proposal would increase levies on households making more than $400,000 compared with the $200,000 for individuals and $250,000 for couples that he has campaigned on since 2007.

Will households making $250,000 to $400,000 see any tax increases?

It’s unclear. Republicans and Democrats have talked about raising revenue by limiting deductions many taxpayers take to reduce their taxable income. Households earning between $250,000 and $400,000 a year would face limits on their tax breaks under Obama’s latest budget offer even though they wouldn’t face higher income-tax rates.

Obama’s latest plan would begin phasing out personal exemptions and limiting itemized deductions at about $250,000 in annual income.

Boehner’s Plan B legislation would have repealed limits on itemized deductions and personal exemptions for top earners. Those limits would be reinstated Jan. 1 if Congress doesn’t act and the Bush tax cuts expire.

What questions remain about the latest administration proposal?

Obama hasn’t released text outlining his current proposal.

The president’s latest offer would set the top tax rates on dividends and capital gains at 20 percent compared with the current 15 percent, according to a person familiar with the talks who requested anonymity to describe the private offer. Combined with tax increases from the 2010 health-care law scheduled to take effect in January, the top rates would be 23.8 percent. Obama had previously called for taxing dividends as ordinary income, which would increase the top rate to as much as 43.4 percent.

Obama has proposed reducing the exemption for the estate tax to 2009 levels of $3.5 million per individual and a top rate of 45 percent. Republicans would have extended the current estate-and-gift-tax limits at $5.12 million a person, indexed for inflation, with a 35 percent top rate.

Isn’t this Congress almost over?

Yes. The new Congress elected Nov. 6 will take office on Jan. 3.

What does that mean?

That means the legislative process must start over and all bills proposed or acted on this year will die. Democrats will gain seats in the House and Senate. Republicans will still control the House and have procedural power to block action in the Senate.

Is the debt ceiling part of the negotiations?

Yes. The U.S. will reach the $16.4 trillion debt ceiling this year, and Treasury can use so-called extraordinary measures to extend the deadline until at least mid-February, according to the Congressional Budget Office. Republicans say they want spending cuts equal to the size of a debt-limit increase. The administration wants to remove the requirement that Congress approve future increases.

Does anything have to happen before Dec. 31?

As many as 100 million U.S. households, or two-thirds of the total, may not be able to file their tax returns until at least late March 2013 if Congress doesn’t reach an end-of-year budget agreement, according to the Internal Revenue Service. The alternative minimum tax, a parallel tax system once designed to affect the wealthy, is scheduled to affect about 28 million additional households for tax year 2012, up from about 4 million otherwise. Without legislation to prevent that, the IRS would have to delay the start of tax filing season in January. The IRS has said there is no “magic time” by which the agency needs an answer from Congress.

What happens if the U.S. goes “over” the cliff?

The Congressional Budget Office projects that the economy would go into recession in the first half of 2013 if the tax increases and spending cuts occur and aren’t retroactively resolved.

How will markets react if no agreement is reached by Jan. 1?

On Dec. 21, stocks sank around the world after House Republican leaders scrapped Boehner’s plan to allow higher taxes and budget talks stalled. The Standard & Poor’s 500 Index retreated 0.9 percent to 1,430.15 in New York. The Dow Jones Industrial Average slid 120.88 points, or 0.9 percent, to 13,190.84. The benchmark 10-year Treasury note yield dropped three basis points, or 0.03 percentage point, to 1.76 percent at 5 p.m. New York time on Dec. 21, according to Bloomberg Bond Trader data.

What is sequestration and how does it work?

Sequestration is the official name for the automatic spending cuts, half of which would be in defense programs. The cuts are across-the-board, giving agency officials little discretion on how to achieve them. Defense programs would face a 9.4 percent cut and most other agencies would be cut by 8.2 percent, the administration said earlier this year.

Is it really a cliff or is it more of a slope?

A slope may be a better metaphor. Most of the effects --the higher income tax rates and the spending cuts -- would occur gradually during 2013 and not deliver an immediate economic shock. For example, the Treasury Department has at least some authority to freeze paycheck withholding even if higher tax rates are in place. The IRS said Dec. 21 that it will issue guidance to employers by Dec. 31.

Are there some changes that won’t depend on negotiations?

Yes. A 3.8 percent increase on income earned from investments, rents and so-called passive activities is set to take effect Jan. 1 as a result of the 2010 health-care law. That means U.S. income tax rates for top earners and investors will go up for the first time since 1993.

Republicans opposed the health-care law and wanted to repeal it if Obama was defeated for re-election. The law also imposes a 0.9 percent additional tax increase on wages next year. Both surtaxes apply to individuals earning more than $200,000 a year or couples earning more than $250,000. An excise tax on medical devices also will take effect.

To contact the reporters on this story: Margaret Collins in New York at mcollins45@bloomberg.net; Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at Jschneider50@bloomberg.net

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