What is the “fiscal cliff”?

The “fiscal cliff” describes a combination of tax increases and spending cuts that would take effect on Jan. 1 unless Congress and President Obama work out a compromise plan for reducing the federal deficit.

Why are we approaching the cliff?

Simply put: partisan gridlock and election-year politics. Congress and the president actually agreed to the double-punch of tax increases and across-the-board spending cuts on the assumption that it would force the sides to come up with a better plan for lowering the deficit. But as the presidential and congressional elections neared — and as the political gamesmanship intensified — Democratic and Republican leaders lost interest in honest negotiating.

What taxes would go up? And for whom?

Many taxes would rise and upwards of 90 percent of taxpayers would take a hit, to some extent. The nonpartisan Tax Policy Center estimates that, overall, the country’s “tax liability” will increase $536 billion, or 21 percent, from 2012 levels. To be accurate, however, many of the changes are the result of tax cuts that are expiring, not new tax increases.

The lowest-income taxpayers would see their tax bills rise by an average of $412 in 2013 if all of the tax changes took effect, while those in the middle would pay $1,984 more and those in the upper tier would pay $14,173 more, according to the Tax Policy Center.

Examples?

Unless Congress acts, income tax levels will revert back to what they were before President George W. Bush and Congress cut them. So instead of tax rates of 10 percent to 35 percent, we would all be paying 15 percent to 39.6 percent. Another chunk of your paycheck would disappear thanks to the expiration of a temporary 2 percent reduction in the Social Security payroll tax.

An estimated 26 million American taxpayers — those earning more than $33,750 individually and $45,000 if married-filing-jointly — could be subject to the Alternative Minimum Tax for the first time.

The so-called “marriage penalty” — which used to result in some couples paying more jointly than they would have individually — would kick back in. Capital gains taxes would rise from 15 percent to 20 percent for many filers, and the per-child tax credit would fall from $1,000 to $500. And if someone wealthy (or land-rich) in your family died, the estate tax would apply to estates valued at $1 million or above compared to the current $5 million.

So what’s the disagreement?

Both parties in Washington agree that allowing this massive batch of tax increases to hit recession-weary Americans all at once should be avoided. The dispute is whether to shield everyone from the tax increases — as Republicans have insisted — or only those earning less than $250,000, as the president and the Democrats have advocated

What about the spending cuts?

The last-resort deficit reduction plan due to kick in Jan. 1 requires roughly $500 million in across-the-board spending cuts as a first installment of $1.2 trillion in cuts spread over 10 years. Medicare and Social Security benefits as well as critical defense programs are all largely exempted. But nearly every other expenditure in the federal budget — whether it pays for new fighter jets or supplies at the U.S. Mint — would be reduced by between 2 and 10 percent. Half of the cuts would come from non-critical defense programs alone.

Which cuts could hit Maine hardest?

While many federal programs used by Mainers would be affected, cuts to a few programs could have disproportionate impacts here. For instance: an estimated $2.1 billion reduction in funding for Navy shipbuilding and conversion could affect employment at Bath Iron Works, the Portsmouth Naval Shipyard and all of the other businesses that support them. The Low Income Home Energy Assistance Program, or LIHEAP, that provides emergency assistance to Mainers struggling to afford heating oil would take an estimated $285 million hit. And the federal Women, Infants and Children nutritional program for low-income families could lose more than $500 million next year.

Maine has a large population of veterans. Would they be affected?

No, most Department of Veterans Affairs programs and veterans assistances programs are exempted from the cuts.

What would happen if Congress doesn’t act?

The Congressional Budget Office predicted the sudden jolt could very well plunge the economy back into a recession, lowering the gross domestic product by 0.5 percent and driving unemployment back above 9 percent. It might only last a year, however.

Another downturn in the U.S. economy would likely be felt in other parts of the world, too, including in financially struggling European countries.

Is there an up-side to the fiscal cliff?

Going over the fiscal cliff would result in the largest, single-year reduction in the federal deficit in more than 40 years, according to the CBO. So some economists have suggested that the temporary economic pain might be worth the long-term fiscal benefits.

Will Congress and the White House act?

Since the election, all sides are indicating a new willingness to compromise. They also continue to insist it is the other side that should make the big concessions that would avoid driving the economy off the cliff.

Washington Bureau Chief Kevin Miller can be contacted at 317-6257 or at:

kmiller@mainetoday.com

Twitter: @KevinMillerDC