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US Congress Finally Passes Temporary Fiscal Fix

by Mike Godfrey,, Washington

03 January 2013

Even though an agreement was reached beyond the deadline for such a deal, President Barack Obama, the Senate and the House of Representatives have approved a deal that has avoided the major part of the "fiscal cliff" that would have affected the United States from January 1, 2013, and could have put it back into economic recession.

During the course of the last month, both President Obama and the Republican Party’s chief negotiator John Boehner (R – Ohio), Speaker of the Republican-led House of Representatives, had moved from their previously-fixed positions over the Bush tax cuts renewal.

However, in the event, the new deal was put together in the Senate by its Republican leader Mitch McConnell (R – Kentucky) and Vice President Joe Biden, with the Republican Party moving the most as it gave up on both of its previously-stated principles – that all of the Bush tax cuts should be renewed, even for the wealthiest taxpayers, and that significant spending cuts should be agreed. Boehner had, only recently, been unable to garner enough Republican support in the House for a proposal that would not have extended the Bush tax cuts for those earning over USD1m annually.

Under the new deal, the President has had to accept a compromise. His previous position was that he would never sign an extension of the Bush tax cuts for those earning over USD250,000, but the agreement will now see income tax raised only on those individuals with annual earnings over USD400,000 and households earning over USD450,000.

However, while the fate of the Bush tax cuts had garnered the most publicity, the impending tax hikes in the "fiscal cliff" included the expiry of other temporary tax measures, most of which have also been included in the new agreement.

Most importantly, the annual Alternative Minimum Tax (AMT) patch has been renewed. Without it, the 26% AMT, or 28% on higher incomes, would have become payable by 33m taxpayers for tax year 2012 (with returns filed in the spring of 2013).

In addition, while the 2% payroll tax reduction has not been renewed, there has also been a compromise over the estate tax rate. Without an agreement, the current USD5m exemption limit and estate tax rate of 35% would have been hiked to a 55% tax rate, with the exemption limit lowered to USD1m. Under the new deal, the exemption limit will remain at an inflation-linked USD5m, but estates above that level will now be taxed at a maximum rate of 40%.

Tax rates on dividends and capital gains will also not rise as far as the Democrat Party had suggested. For individuals on incomes over USD400,000 and joint filers earning over USD450,000, these taxes will be raised to 20% from 15%, while the provisions ended by the Bush tax cuts of 2001, that phased out personal exemptions and deductions for the more wealthy, will be reinstated, beginning at USD250,000 for individuals and USD300,000 for couples.

All of the new tax arrangements for earnings, investment income and estates, and the AMT, will become permanent, while a whole raft of other "tax extenders" have been extended to the end of 2013. The latter include, for individuals, mortgage tax relief, the deduction for state and local sales taxes, education tax deductions, and tax-free distributions from individual retirement accounts for charitable purposes; and, for businesses, the research and development credit, the new markets tax credit, 50% bonus depreciation, and the "cover over" of rum taxes for Puerto Rico and the Virgin Islands.

However, Republicans have been most perturbed by the agreement to kick around USD24bn in automatic spending cuts across all federal departments down the road for two months (to March 1, 2013), to allow for further negotiations on where more specific reductions should be implemented.

As Boehner pronounced after the House vote, "now the focus turns to spending. The American people re-elected a Republican majority in the House, and we will use it in 2013 to hold the president accountable for the 'balanced' approach he promised, meaning significant spending cuts and reforms to the entitlement programs that are driving our country deeper and deeper into debt.”

In that case, while the President said that he "will not have another debate with this Congress over whether or not they should pay the bills that they’ve already racked up through the laws that they passed," he can expect that, during the next two months, Republicans will insist that a reduction in the cost of his health care reforms and other benefit programs will be explicitly linked to the negotiations that will be necessary over an increase to the federal debt limit.

It is not just by chance that two months of grace have been given for the discussions on spending cuts. The Treasury Secretary had already informed Congress last month that the statutory debt limit would be reached on December 31, 2012, and that, "by taking certain extraordinary measures authorized by law to temporarily postpone the date that the US would otherwise default on its legal obligations… the amount of headroom (so produced) would last approximately two months."

TAGS: individuals | tax | economics | business | tax incentives | fiscal policy | law | Virgin Islands | payroll | tax credits | legislation | Puerto Rico | United States | tax breaks | dividends | individual income tax | research and development

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