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Tuesday, December 4, 2012

The Fiscal Cliff

Now that the election is over, all anyone seems to be talking about is the fiscal cliff. Will the government prevent it? What will it take to reach a deal? But most importantly, what will it mean for the average American come tax time.

What is the fiscal cliff?

The fiscal cliff essentially means that on January 1, 2013 if there is no deal to avoid the cliff, automatic spending cuts will take effect. Additionally, Bush's tax cuts that have been in place for almost a decade will also expire. Most people will agree, no matter which side of the political spectrum they are on, that any deal that will prevent us from going over the cliff will be a combo of tax increases and spending cuts. Everyone is up in arms about a solution for the fiscal cliff since the ramifications of both spending cuts and an increase in taxes will cause major problems. The general repercussion is that for an increase in the amount of taxes an individual pays, he will see less in return in terms of government services.

How will a failure to come up with a solution to the fiscal cliff affect the average American family?

Here is the average tax breakdown the a family pays:

10% of income up to $17,400
15% of income from $17,401- $70,700

The "average" family in the U.S. is made up of 2.6 people, earning around $50,000. As it stands now, the base tax rate this "average" family will pay is $4,845. If the Bush tax cuts expire, this family will pay 15% for all income, which equals to $6,397, or an increase of $1,552. For a family making $50,000 this is a huge blow to their budget. This equates to less spending and less spending, never a good thing to jumpstart an economy.

What about deductions?

While our average family above doesn't actually pay $4,845 in taxes, since there are many deductions that lower the tax amount they pay, another potential ramification of the fiscal cliff is the disappearance of many deductions Americans rely on to lower their taxes. For example, the Child Tax Credit gives around a $1,000 deduction, after January 1, it will be around $500. Another example, the 2% social security tax cut (for the first $110,000 in income) is also scheduled to end on January 1. This equates to, for the average family, a $1,000 tax increase.

What's the solution?

Republicans want to prevent the Bush tax cuts from expiring. Democrats don't want too many spending cuts, especially a disproportionate amount of cuts that will affect lower income Americans. As of today,  both sides of the aisle seem more intent on fighting and getting their way than actually coming up with a viable solution. It reamins to be seen what will happen.

Will the fiscal cliff narrowly be avoided like the debt ceiling last year? Will we go over it and suffer the consequences? Stay tuned. The literal ball will drop at midnight on January 1st, wil the figurative ball drop as well?

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