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The Fiscal Cliff and its Impact on Small Business

Tax Hikes and Spending Cuts set to Trigger at the End of 2012

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The Fiscal Cliff and its Impact on Small Business

fiscal cliff

November 12, 2012

Even before President Obama was re-elected, there were discussions about the "fiscal cliff" that exists at the end of 2012 and the danger of the U.S. falling off this fiscal cliff. What is the fiscal cliff and how does it impact small businesses?

The fiscal cliff is the term used for the man-made, or politican-made, problem that has resulted because of the inability of the Congress and the President to work together during President Obama's first term in office. As a result of that stalemate, there are a number of significant financial events taking place at the end of the year that, together, could constitute a severe economic contraction and a drop in our gross domestic product during 2013. When the politicians, over the last few years, could not reach an agreement about one issue or another, they just kept putting off the decisions or "kicking the can down the road." None of the big problems ever got solved. The fiscal cliff resulted when the deadline for all these problems is happening at once at the end of 2012.

These financial problems are a series of tax hikes and spending cuts by the federal government that will happen unless the federal government takes some sort of action by 12/31/2012. This is called the fiscal cliff. The Congressional Budget Office projects that around $800 billion in tax hikes and spending cuts will happen in 2013 if the decisions the politicians refused to make go unmade again this year.

What Composes the Fiscal Cliff?

Bush Tax Cuts: The Bush tax cuts will expire on 12/31/2012. President Obama wants to renew the Bush tax cuts for everyone who makes under $250,000. The Republican House wants to renew the Bush tax cuts for everyone including those who make more than $250,000. This is going to be one of the arguments over the fiscal cliff.

The first Bush tax cut, in 2001, was enacted to stimulate the economy during the 2001 recession. The second Bush tax cut increased tax deductions for small businesses and lowered the capital gains tax from 20% to 15%. Never did anyone imagine that these tax cuts would become such a political hot potato so many years later.

Most think tanks and economists think that dropping the Bush tax cuts for those with incomes over $250,000 will not substantially hurt small business. A Treasury Department study found that only 2.5% of small businesses are in the tax brackets with incomes above $250,000. The claims that allowing the Bush tax cuts for the top tax brackets to expire would negatively affect small business are misleading.

There are other provisions in the Bush tax cuts that affect primarily individuals and might affect some small businesses. These provisions include the expiration of tax cuts on income, investments, the married couples benefit, tax provisions for families with children, and protection for inheritances.

In addition to the Bush era tax cuts that will be lost, other issues on the table that comprise the fiscal cliff are the expiration of unemployment benefits for the long-term jobless, a large reduction in reimbursements to doctors participating in Medicare, the imposition of the alternative minimum tax on 26 million additional households, the expiration of President Obama's 2% payroll tax holiday, and a number of smaller cuts for households and businesses.

Automatic Spending Cuts: Last year, Congress failed to reach any sort of bipartisan agreement on debt-reduction. As a result, the Budget Control Act was passed. The provisions of this Act requires that automatic spending cuts begin on January 2, 2013 that will reduce the deficit by $1.2 trillion over 10 years. Just the 2013 portion of the spending cuts will take a deep chunk of money out of the economy. Discretionary defense spending will sustain a deep cut of $55 billion in 2013. Non-defense spending will also be cut by $55 spending including programs like education.

What can be Done to Avert a Crisis?

This situation is quite serious and is the results of complications of a political impasse between Congress and the White House between about 2013 and the present day. One can think back to the beginning of the first term of the President in 2008 and remember that Kentucky Senator, Mitch McConnell stated that his entire mission for the next four years was to make sure that Obama was a one-term President. With thinking like that on Capitol Hill, no wonder nothing can be accomplished - and now look where it has gotten us.

Not only do Congress and the President have to find a way to compromise by the end of the year for the good of the American people, but they also have to do this for the credit rating of the U.S. Government. When the U.S. Congress and White House had such a bitter fight over the debt ceiling in 2011, Standard and Poor's downgraded our debt from AAA to AA+. However, there are three credit reporting agencies. Now, both Fitch and Moody's credit reporting agencies have said that failure to reach a bipartisan compromise on a debt-reduction plan by the end of the year will cause them to lower the U.S. credit rating as well.

What is likely to happen is another hard-fought compromise that moves us forward very little. The politicians can cancel some or all of the tax hikes and spending cuts which would greatly increase the debt of the U.S. and throw us into a debt crisis approaching the one facing Europe. On the other end of the spectrum, they could let the tax hikes and spending cuts go into effect. The deficit would be cut substantially but the average American family would be hurt as well as American businesses. A middle of the road compromise, if our politicians can compromise, is available.

It is hard to know what the middle of the road approach would look like but it would probably involve some combination of keeping part of the Bush tax cuts and either stopping the automatic spending cuts or substantially cutting them back. What I see in the President's future is the absolute necessity to find a way to compromise with the Republican House, not just on the fiscal cliff but on everything that comes afterward.

The President and the Congress have a big, difficult job ahead. If you have solid opinions on these issues, write your Congressman. One of the other About.com Websites has great information about how to go about doing that. Check it out here.

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