More speedbump than cliff

There’s a lot of hype about the “fiscal cliff” and the automatic tax increases it will cause, but in reality it won’t make much difference to most households.

The “fiscal cliff” is the unfortunate name we’ve ended up with for a deal that President Obama made with a hostile Congress in 2011. In exchange for postponing balancing the budget at a time when the year-long election campaign made it impossible to reach agreement, the deal set up a large number of automatic but delayed tax increases and spending cuts, to take effect on January 1st or 2nd 2013. If Congress is unable to agree a better policy package, income tax rates will return to their levels before George W. Bush cut them in his first term, and federal government spending will be cut dramatically. My research shows that the tax side of this equation is not as drastic as it sounds, and that the deal Congress rejected in August 2012 would have spared all but the 1% from tax increases.

The chart below superimposes three scenarios; click on these links to choose between them:

  • The status quo if 2012's tax rates were extended.
  • The "fiscal cliff" scenario if Congress can't agree anything. Note that even though marginal tax rates would return to their 2001 values, most people would still be paying slightly less tax than they did then, because the distribution of income has changed. The exception: the richest 1%, who would pay more tax because they're making even more money.
  • Obama's compromise proposal that Congress rejected in August 2012. In this scenario, the only people whose taxes would have gone up at all were the richest 1%.
  • The 3 scenarios superimposed.
Income tax scenarios for 2013
status quo thumbnail fiscal cliff thumbnail August proposal thumbnail superimposed thumbnail

Notes

Click through for another view of how the three scenarios compare.

This chart says nothing about the spending cuts that the fiscal cliff will trigger, or taxes other than income tax. While the income tax changes are the biggest single component of the fiscal cliff, they are only just over a third of the total package value. This primer from the Tax Foundation lists the whole package.

To approximate household incomes, the chart above shows the combined rate for a married couple filing together. I've assumed they don't claim any exemptions, to keep things simple, so in reality everyone would be paying slightly less, and a household with children a good deal less.

This is a chart of effective tax rates as opposed to marginal tax rates. While a couple earning $500,000 is nominally taxed at the top rate (which has been 35% since 2003), that only applies to the share of their income above the threshold for that bracket (which is $388,350 in 2012). Income below that threshold is taxed at the next level down, and so on, which is why they end up with an effective tax rate several points below their marginal rate.

Rather than plotting fixed income amounts on the chart, I plotted lines for key percentiles. The 20th percentile income is the income at which 20% of households are earning less, and 80% more. I find this more relevant than static numbers because it takes account of inflation and recessions, but it is also why the lines wobble around a little between 2003 and 2012 even though no tax rates were changed. The choice of the 20th, 40th, 60th, 80th & 95th percentiles was motivated by the Census Bureau having extensive data on those thresholds, and I added the 99th percentile in because it represents the top 1% that has been the subject of popular outrage.

The tax bracket boundaries for 2013 and the income percentile boundaries for 2012 and 2013 are estimated data, because I am writing this in December 2012, when the real numbers are not yet known.

Sources

Data

Download the Excel file I used to generate the charts, or a CSV file of just the numbers.