Fiscal Cliff Talks at Stalemate Over Dueling Tax Plans

U.S. President Barack Obama
Negotiations over the so-called fiscal cliff are stalled as President Barack Obama and Republicans trade offers on ways to avoid more than $600 billion in U.S. spending cuts and tax increases for 2013 that will start to take effect in January if Congress doesn’t act. Photographer: Andrew Harrer/Bloomberg

Negotiations over the so-called fiscal cliff are stalled as President Barack Obama and Republicans trade offers on ways to avoid more than $600 billion in U.S. spending cuts and tax increases for 2013 that will start to take effect in January if Congress doesn’t act.

Here are questions and answers about what the fiscal cliff means and what each side is demanding in the talks:

Who created the fiscal cliff?

Congress and Obama did. In 2010, they extended the George W. Bush-era tax cuts for two years, meaning that tax 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. In 2012, they extended a two-percentage-point reduction in the payroll tax through Dec. 31. That confluence of events is designed to put pressure on Congress to act on taxes, spending and the budget deficit.

If the cliff is so bad, why can’t Congress stop it?

They can, though lawmakers disagree on what to do. All sides want to continue the tax breaks for individuals making up to $200,000 a year and married couples earning up to $250,000 a year. Republicans, who control the House of Representatives and oppose tax-rate increases, see the cliff as leverage to push Obama to cut spending on programs such as Medicare and Medicaid. Democrats, who control the Senate, favor higher tax rates for top earners and fewer cuts in social programs and entitlement spending.

Where do the negotiations stand now?

House Speaker John Boehner, an Ohio Republican, sent a letter yesterday to Obama outlining the framework of a House Republican proposal. Within two hours, White House Communications Director Dan Pfeiffer rejected the plan, saying in a statement that it “promises to lower rates for the wealthy and sticks the middle class with the bill.”

What do Republicans want?

They want to extend all of the expiring tax cuts on income, capital gains, estates and dividends for one year and then overhaul entitlement programs and the tax code. The House has passed bills that would extend the tax cuts and delay automatic spending cuts that would affect defense programs. They say they are willing to put revenue on the table without higher tax rates.

What was their offer to Obama?

Republicans made a $2.2 trillion proposal yesterday that called for $800 billion through a rate-lowering, base-broadening overhaul of the U.S. tax code. They would reduce entitlement programs by $900 billion and other spending by $300 billion. They also would save $200 billion by changing a government inflation measure that would affect tax brackets and slow increases in Social Security benefits.

Are Republican leaders proposing an $800 billion tax increase?

Yes. Republican aides said the $800 billion revenue increase would be scored conventionally, which means that it wouldn’t rely on economic growth caused by the tax plan itself. Obama and congressional scorekeepers would define that as a tax increase. Previous Republican proposals have relied on fees and other non-tax ways of raising revenue.

What does Obama want?

The president wants $1.6 trillion in tax increases over the next decade. He has proposed $600 billion in spending cuts, about $350 billion of which would come from health-care programs. He also counts the $1 trillion in spending cuts Congress passed in 2011, $800 billion in savings from winding down the wars in Iraq and Afghanistan and $600 billion in interest savings, according to senior administration officials. Leaving aside the administration’s call for measures to boost short-term economic growth, which could take the form of tax cuts or spending increases, this would result in $2.4 trillion in spending cuts and $1.6 trillion in higher taxes.

What’s the $1.6 trillion in taxes Obama is talking about?

The administration’s plans call for a two-stage tax increase that would raise taxes by $1.6 trillion over 10 years. Right now, they want to let the 2001 and 2003 tax cuts expire for top earners. That would push the top tax rate on capital gains to 23.8 percent, the top rate on ordinary income to 39.6 percent and the top rate on dividends to 43.4 percent. The plan would reinstate limits on personal exemptions and deductions.

What comes in stage two?

By Aug. 1, the administration wants Congress to pass a plan that would enact the rest of the administration’s tax agenda -- about $600 billion in higher taxes. What the administration has proposed in its budget beyond the immediate rate increases is about $1 trillion in tax increases and about $360 billion in tax cuts. That’s a net tax increase of more than $600 billion.

Some of the increases would make it more difficult for U.S.-based companies to defer taxes on income earned overseas. The cuts include a permanent extension of a tuition tax credit and the credit for corporate research. The biggest increase would reduce the value of top earners’ tax breaks by requiring them to take such breaks as if they paid taxes in the 28 percent bracket.

What’s not clear about the administration’s tax plans?

After the administration released its budget plan in February, Obama called for a corporate tax rate cut that would be paid for by using some of the same business tax increases that are in the budget. Administration officials haven’t said whether the business tax increases would go toward deficit reduction or the rate cut.

Will taxes really rise by $1.6 trillion?

It’s doubtful. Obama’s plans include taxing dividends as ordinary income and higher estate taxes. Senate Democrats, when they passed a bill earlier this year, didn’t endorse the president’s version.

What’s included in Obama’s spending cuts?

The biggest item in Obama’s $350 billion in Medicare and Medicaid cuts would save $137 billion by requiring drugmakers to provide Medicare with the same rebates as they provide for low-income Medicaid patients. Obama would save an additional $45 billion by cutting reimbursements for post-acute care, such as rehabilitation hospital services and home-health calls for recovering surgical patients.

What do Republicans want on spending?

Ideally, they want the plan advanced by House Budget Committee Chairman Paul Ryan, a Wisconsin Republican, to provide subsidies to Medicare patients to buy private insurance, and turn Medicaid over to states by providing them with block grants. In the future, Congress would designate a set amount for an individual’s coverage, which over time could fall behind the pace of rising health costs, meaning more out-of-pocket expenses for beneficiaries. Short of that, Republicans have talked about ideas such as raising the Medicare eligibility age.

Would both parties cut the deficit by the same amount?

They are close. Measured by the same yardstick, Obama wants $2.2 trillion of deficit reduction and $200 billion of stimulus spending. Republicans want $2.2 trillion of deficit reduction. Those come on top of the $2.4 trillion from already enacted cuts, war savings and interest savings.

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 pass future increases.

Is there room for a compromise?

There is room between the two positions. Senator Max Baucus, a Montana Democrat and chairman of the Finance Committee, said he thought a tax increase of at least $1 trillion and “significant” spending cuts would be the path to a deal. There isn’t much time left, and both sides have taken a hard line on some of the most important issues, such as tax rates and what tax increases or spending cuts would happen immediately.

What’s the deadline?

Dec. 31. After that, the tax increases take effect and the spending cuts start. Those policies can be reversed retroactively.

Does anything have to happen before Dec. 31?

The alternative minimum tax, a parallel tax system once designed to affect the wealthy, is scheduled to affect about 28 additional million households for tax year 2012, up from about 4 million otherwise. Without legislation to prevent that, the Internal Revenue Service has said it would delay tax filing scheduled to start in January until at least late March for about 60 million filers. Action isn’t required, though the consequences of inaction are quick and severe.

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?

If history is a guide, stock markets have reacted negatively to past hiccups before recovering. The Standard & Poor’s 500 Index fell as much as 0.6 percent on Nov. 27 after Senate Majority Leader Harry Reid, a Nevada Democrat, said there had been no headway made on a compromise beyond initial “happy talk” from Republicans. It declined 0.5 percent in three minutes on Nov. 29, erasing an earlier rally, after Boehner said “no substantive progress” had been made toward a deal. It recovered as Senator Chuck Schumer, a New York Democrat, said there has been progress in talks, and the index ended the day with a 0.4 percent gain.

Bond markets have gained on pessimistic news. The benchmark 10-year Treasury note yield fell for the fifth of six weeks ending Nov. 30 as Obama warned on that day of “prolonged negotiations” ahead on deficit reduction, while Boehner said “right now, we’re almost nowhere.” The yield on the 10-year note fell seven basis points, or 0.07 percentage point last week to 1.62 percent in New York, according to Bloomberg Bond Trader prices and was 1.63 percent at 8:26 a.m. today in New York. The yield fell to a record low of 1.379 percent in July and a 2012 high of 2.4 percent in March.

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.

Are other pieces of the fiscal cliff not getting as much attention as the income tax increases and spending cuts?

Yes. The cliff also includes a scheduled cut in doctors’ reimbursements under Medicare, less expansive unemployment insurance and the lapse of business tax breaks for items such as wind energy, multinational companies’ overseas finance, income and short-line railroad track maintenance.

Are there some tax increases that don’t depend on fiscal cliff 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. Republicans opposed the law and had hoped to repeal it if Obama was defeated for re-election. There’s also a 0.9 percentage increase on wages scheduled for next year as a result of the same legislation. 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.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE