Over The Tax Cliff

I don't know if President Obama has planned it this way but we are heading over a tax cliff on January 1, 2013.  What is so troubling is that we are on automatic pilot heading for the cliff.  If nothing is done there will be gigantic tax increases beginning in 2013.  With a Presidential election year in front of us and both parties thinking they may end of in a better position come 2013, there is a real risk that nothing will be done. The result-huge tax increases automatically take place as a number of tax cuts and benefits expire at the of next year. 

The Wall Street Journal summarizes what we are looking at when the calendar reaches January, 2013 under current law.

President Obama unveiled part two of his American Jobs Act on Monday, and it turns out to be another permanent increase in taxes to pay for more spending and another temporary tax cut. No surprise there. What might surprise Americans, however, is how the President is setting up the U.S. economy for one of the biggest tax increases in history in 2013.

Mr. Obama said last week that he wants $240 billion in new tax incentives for workers and small business, but the catch is that all of these tax breaks would expire at the end of next year. To pay for all this, White House budget director Jack Lew also proposed $467 billion in new taxes that would begin a mere 16 months from now. The tax list includes limiting deductions for those earning more than $200,000 ($250,000 for couples), limiting tax breaks for oil and gas companies, and a tax increase on carried interest earned by private equity firms. These tax increases would not be temporary.

What this means is that millions of small-business owners had better enjoy the next 16 months, because come January 2013 they are going to get hit with a giant tax bill. Let's call the expensive roll:

• First comes the new tax hikes that Mr. Obama proposed on Monday. Capping itemized deductions and exemptions for the rich would take $405 billion from the private economy for 10 years starting in 2013. Taxing carried interest would raise $18 billion, and repealing tax incentives for oil and gas production would get $41 billion.

• These increases would coincide with the expiration of the tax credits, 100% expensing provisions and payroll tax breaks in Mr. Obama's new jobs program. This would mean a tax hit of $240 billion on small business and workers. That's the downside of temporary tax breaks and other job-creation gimmicks: The incentives quickly vanish, and perhaps so do the jobs.

So even if the White House is right that its latest stimulus plan will create "millions of jobs" through 2012, by this logic a $240 billion tax hike on small businesses in 2013 would cost the economy jobs. This tax wallop would arrive when even the White House says the unemployment rate will still be 7.4%.

• January 2013 is also the same month that Mr. Obama wants the Bush-era tax rates to expire on Americans earning more than $200,000. That would raise the highest individual income tax rate to about 42%, including deduction phaseouts, from 35% today. Congress's Joint Committee on Taxation found in 2009 that $437 billion of business income would be taxed at higher tax rates under the Obama plan. And since some 4.5 million small-business owners file their annual tax returns as subchapter S firms under the individual tax code, this tax increase would often apply to the same people who Mr. Obama is targeting with his new tax credits.

The capital gains and dividend taxes would also rise to an expected 20% rate from 15% today. The 10-year hit to the private economy for all of these expiring Bush rates: about $750 billion.

• Also starting in 2013 are two of ObamaCare's biggest tax increases: an additional 0.9-percentage point levy on top of the 2.9% Medicare tax for those earning more than $200,000, and a new 2.9% surcharge on investment income, including interest income. This will further increase the top tax rate on capital gains and dividends to 23.8%, for a roughly 60% increase in investment taxes in one year.


Of course, The Wall Street Journal is assuming that the Bush tax cuts for those making $200,000 and less would be extended.  However, these are also scheduled to expire on December 31, 2012.  Unless an extension is signed into law these cuts would also end.

The only prudent course is for Congress to seriously tackle major tax reform early in the coming year.  The looming tax increases at the end of the year should provide the incentive to get something done.  This is particularly the case if tax reform is also paired with the work of the Super Deficit Committee to reduce spending. 

We should be looking to broaden the base of both individual and corporate taxes.  Get the federal government out of the business of picking winners and losers with deductions, credits, allowances and exemptions.  Simplify the Internal Revenue Code and lower rates across the board.  It is time to use the tax laws to simply raise revenue and stop the social and economic engineering that has become the essence of tax policy.  That is the tax reform we need to keep from going over the tax cliff at the end of next year.