The
bill, which prevents the United States from being hit with a set of tax increases
and spending cuts simultaneously this month, passed in the House in a
bipartisan 257-167 vote.
Of
course, many are wondering what exactly the hefty 150-page bill means and what
it does. But don’t worry. Derek Holt, Scotiabank’s vice-president of economics,
has a handy breakdown of what last night’s legislation actually does.
Here’s
a look at his explanation, which looks at who the bill hurts, who it benefits,
and what remains to be seen.
WHO
IT HURTS
1.
The 2% social security payroll tax cut to the workers’ share is gone
permanently. As a consequence, disposable income will decline in January and
Q1. By how much? Up to about $2,400 annually for those with earnings at the
2013 cap of $113,700 or more. Just under half that for the roughly average family.
This measure is generally thought to knock about a half point off of annual GDP
growth and is likely to hit consumption in Q1-Q2. It never really achieved the
desired positive impact upon job creation. The hike is also likely to weigh
upon consumer confidence through assessments of present conditions when lower
after-tax paycheques are realized.
2.
Upper income earners (individuals earning over $400k and joint filers over
$450k) face a permanent hike in their marginal tax rate to 39.6%. President
Obama has remarked that further increases will be sought as part of additional
negotiations in 2013 to reduce spending and raise revenues. Thus, we cannot yet
evaluate the full tax implications for upper income earners.
3.
For the same definitions of upper income earners, taxes permanently rise on
capital gains and dividends from 15% previously to 20% now. Those below the
income thresholds will pay a permanently capped 15% rate except for lower
income earners that pay nothing.
4.
The top estate and gift tax rate will rise to 40% from 35% previously for those
above the exemption. The estate and gift tax exemptions will remain at $5
million or more per individual (not the $3.5 million at a 45% rate that the
White House sought).
5.
Tax refunds for early filers will be delayed as the tax filing season will be
delayed by several weeks. That will push income out of the early months of 2013
into ensuing months. As a consequence, seasonal adjustment factors for income
will be distorted for months and it may take until Q2 before we get cleaner
data to evaluate trend income growth.
6.
Personal exemptions and itemized deductions will be capped for individuals
earning over $250k and couples earning over $300k. This is a permanent
restoration of the Personal Exemption phase-out, or Pease provision after the
late Donald Pease (Democrat). The formula based approach is thought to add just
over 1% to the highest marginal tax rate.
7.
401(k) plans will be rolled into Roth IRA plans and hence taxes will have to be
paid up front on gains in the plan. The carrot is that pay-outs from Roth plans
are not taxed. Roth plans offer no tax deductions on contributions but shelter
investment income upon distribution. They contrast with 401(k) plans that offer
deductions on contributions, but then tax investment income flows upon
withdrawal. Washington’s move therefore captures higher near term tax revenues
at the expense of longer term tax revenues as baby boomers retire. It is likely
a relatively short-sighted near term revenue grab that fits the pattern of
kicking the can down the road.
8.
A pay freeze for members of Congress has been extended for another year. A
freeze on pay for federal government workers has been allowed to expire.
WHAT
WILL HELP
1.
Those earning up to $400k/$450k individual/household income will have the Bush
era tax cuts permanently extended. This is not added stimulus, but averts a tax
hike for 99% of filers. Some may question whether permanent extensions
represent good policy for a heavily indebted government running enormous long-term
deficits and I wouldn’t be surprised to see ‘permanent’ being revisited in
future.
2.
The broadening of the alternative minimum tax in 2013 would no longer occur.
3.
Depreciation incentives for businesses to write off up to 50% of equipment
spending will be extended for another year. This is a plus for business
investment, but it requires confidence for its effects to be unleashed and that
isn’t likely until later in the year.
4.
Unemployment insurance benefits that were lengthened in the crisis would be
extended for another year at a CBO estimated cost of $30 billion. We’ll be
having that portion of the debate again by late 2013. At nearly two years, the
US offers as generous jobless insurance as the most liberal of European
economies.
5.
Other miscellaneous tax measures (deductions for teachers, charitable
donations, state sales taxes) will be extended for varying periods with
retroactive extensions for provisions that expired in early 2012. The American
Opportunity Tax Credit is extended for five years, as is the Child Tax Credit
and Earned Income Tax Credit.
6.
A scheduled cut in Medicare payments to doctors will be delayed a year.
7.
At least for now, the GOP fully backed away from efforts toward using chained
CPI indexing of entitlement spending which would have represented cost savings
to the government.
WHAT
REMAINS TO BE ADDRESSED
There
is no agreement on the debt ceiling which has now been surpassed. A large risk
facing the US economy is how $110 billion in spending cuts that have now been delayed
for two months in this agreement will be tied to an increase in the debt
ceiling that will be required by February or March after the Treasury takes
extraordinary measures to postpone the ceiling’s binding effects. This will be
a significant concern to markets for some time as this mini-deal fails to
address the spending and borrowing sides of the picture. It may be that the GOP
waved the white flag on the first leg of the negotiations, only to gain
leverage in their quest for spending cuts by an administration that is thus far
demonstrating little concern for the fiscal position of the United States.
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