Tax policy was a point of great interest during this year’s presidential campaign. Heated debate and disagreement were sparked over radically different notions proposed by the Republican and Democratic Party. Despite their differing policies, both Republican Romney, and Democratic president Obama, aimed to construct a solution to the ever-looming 2013 fiscal cliff.

The fiscal cliff explained:

US company registrationThe fiscal cliff is a package of spending cuts and tax rises which will hit the US on 1 January 2013. The US has about $2.3tn of money coming in but spends about $3.6tn, thus the spending cuts and tax hikes are to compensate for the $1.3tn debt

The $1.3tn debt will be paid off over a period of ten years, and thus the US must cover $109bn each year, which will be taken from the federal budget. Half, or $54.7bn, are to defense spending, and the other half are to government programs, like Medicare, which will loose $11bn and will pay doctors 30% less. The other cuts will hit student loan fees and various government offices.

The disappearance of the Bush era tax cuts will cause the top tax rate to rise to 39.6% from 35%; social security taxes will also go up to 6.2% from their current rate of 4.2%, and a small tax will be imposed on high earners to pay for the new Affordable Care Act.

The Alternative Minimum Tax, or AMT, will run out at the end of the year. The AMT is a flat tax, usually for people who are high earners. Currently it applies to approximately 4 million people, and if the US goes into the fiscal cliff, it will apply to about 32 million people. This means that many who consider themselves middle-class will have to pay taxes as if they are the rich.

Tax increase is dependant on one’s income bracket, and could be raised by $3,500 per household

If Congress doesn’t cut a deal:

As the dreaded fiscal cliff approaches, people are questioning what will happen if a deal has not been formed. Many seem to think that Congress will come up with a temporary solution, and will then revisit after six months. However, others are not so optimistic and predict a psychological effect that will snowball into a financial crisis.

With just one month left before the Bush tax cuts expire and automatic spending cuts take hold, markets are anxious about predictions that falling off the fiscal cliff could trigger another recession.

Investors will start panicking in the stock markets, which could start falling sharply. A panic in the business community will be triggered over unknown tax rate for the following year. Panicked CEOs could stop spending and hiring, which could consequently hurt the employment rate.

Fiscal Cliff avoidance:

Currently, Congress is in talks in search of a deal to avoid the year-end fiscal cliff of an automatic series of spending cuts and tax hikes feared to plunge the world back into recession.

Obama has long reiterated his belief of working families and small businesses as the drivers of economic growth. He has thus instigated wide-ranging Bush era tax relief for those earning under US$250,000 to pay down America’s deficit and to invest in its future. He also asks the wealthiest 2% to do their “fair share”, ideas of which stem from the Buffet Rule.

Small business leaders have shown support for Obama’s goal of extending low tax rates for the middle class beyond the end of the year, while letting rates rise for wealthier taxpayers.

Mr Lew Prine, co-founder of an independent music store reports his support to keep middle-class tax cuts by stating, “what grows jobs in America is consumers spending money, and the average person needs that two or three thousand dollars a year in his pocket to help drive the economy”.

Republicans, however, want to extend low tax rates, enacted a decade ago under the administration of former Republican President George W Bush, for all taxpayers, including households earning more than US$250,000 a year. Republicans believe that to raise taxes on the wealthy would be to discourage investment and hiring at a time of high unemployment.

President Obama is expected to maintain a firm stance against, and will not sign any deal that extends, Bush era tax cuts for the wealthiest Americans.  Obama previously stated, “If there was one thing that everybody understood, that was a big difference between myself and Mr. Romney, it was when it comes to how we reduce our deficit, I argued for a balanced, responsible approach — and part of that included making sure that the wealthiest Americans pay a little bit more. By the way, more voters agreed with me on this issue than voted for me.”

The Obama government will attempt to close loopholes that prevent any wealthy companies and individuals from paying their share. President Obama expressed in his first statement since re-election that he is open to compromise in tackling fiscal challenges but is determined to pursue a balanced approach.

The Republicans announced in a post election conference, that they are happy to accept new revenue under the right conditions but the concerns would be where the increase comes from and what reforms are associated with the changes.

For now, there is no deal in sight, only hope that both Republicans and Democrats can come to a effective compromise averting the fiscal cliff.

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