Taxes

'Will all hell break loose?' Your fiscal cliff questions answered

Nov. 14, 2012 at 9:50 PM ET

Chip Somodevilla / Getty Images /
President Barack Obama answered reporters' questions about the fiscal cliff and other issues in the East Room of the White House Wednesday.

ANALYSIS: Hopes for a bipartisan compromise on the "fiscal cliff" threatening the nation's economy are beginning to fade just 10 days after the election that will leave President Barack Obama in the White House and Republicans in command of the House. Obama on Wednesday drew a line in the sand, saying he was confident the problem could be resolved but that he would not approve an extension of Bush-era tax cuts for the wealthiest 2 percent of Americans.

The standoff guarantees that we will be hearing a lot more about the complex budget issue in coming weeks as Congress works against a Dec. 31 deadline, and possibly beyond.

Here are some answers to questions about the fiscal cliff and its impact on household budgets as posed to us by TODAY.com readers in a web chat this week:

Is this fiscal cliff thing going to be resolved soon? If not, will all hell break loose in the markets?? -Jen

The cliff is really more of a slope because the cuts don’t hit all at once on Day One. The tax hikes – if they are allowed to take effect – would raise the average household tax bill by about $68 a week.

Financial markets are concerned about several different issues. Stock investors are worried that the capital gains tax rate will go up, which is why many are selling now before year's ends. (The Dow Jones industrial average is down 5 percent since Election Day.)

The more worrisome reactions would be from the bond market, where investors are still buying Treasury debt at record low interest rates. If they begin to fear that the U.S. government has lost control of its finances, those rates could go higher. That would be very bad news for the economy.

Do you believe raising taxes on the upper 1 percent and closing loopholes is a way to begin to draw down the deficit?

It’s hard to see how you can balance the budget without raising taxes. Call them “revenues” if you don’t like the word “tax.” The hard part is deciding who pays more.

Closing loopholes sounds like a great idea – until the loophole that’s closed is the one that puts money in your pocket. Unfortunately, the most popular loopholes are the most expensive, such as the deduction for mortgage interest. It would be great if cutting subsidies to, say, the oil industry would do the job. But most of the “freebies” go into individuals in the middle of the income ladder. Here’s our story with a list of who gets what.

If these guys can't get their act together, is there an easy way to figure out how much my taxes would go up? I know budgeting is a foreign concept to the guys in Washington, but it's important for me to do a monthly budget, so knowing what my income will be is kind of important. -Ed

Well, they do create budgets. The problem is that they use math and accounting rules that few people on planet Earth can understand.

There have been multiple studies done on the impact of various proposals on specific taxpayer/income groups, but none of these proposals is going to survive intact. So until you see the line-by-line law that results from these budget talks, there’s no way to know how it will impact your tax bill.

You can also expect this to be one of the worst tax-filing seasons in recent memory. Just keeping up with “routine” changes in the law is a challenge for the IRS. It’s a safe bet that a lot of people will be filing extensions this year.

If no deal is reached, will there be money to fund Social Security payments and Federal workers' pay? I know last time that was a big concern. - Matt

If no deal is reached by the end of the year, the government continues paying its bills without interruption. Social Security payments and federal salaries go out as normal. For federal workers, the question is whether the agencies that, by law, have to cut spending will begin laying off workers. That’s also unlikely on Day One. Though the spending cuts are fairly deep, the agencies have broad discretion in how quickly they make them. Some may decide to hold off – expecting a deal to be a reached in a few weeks or months.

We also face another congressional brawl over raising the debt ceiling, which we’ll hit sometime in January. (The exact date depends on how much tax is collected in December.) If Congress decides to play games again with the debt ceiling, that would force a shutdown in spending – and possibly send the Treasury back toward default. The debt ceiling debacle in July 2011 is what produced the law that created the fiscal cliff in the first place.

Can't the Fed just print their way out of this? -Troy

Not really. The Fed has helped ease the pressure on Congress by lowering interest rates, which has lowered the cost of borrowing needed to make up the deficit shortfall. The government paid less interest last year on its $16 trillion in debt outstanding than it did in 2008 on $10 trillion in debt.

But the Fed can’t keep rates low forever. As rates go up, so will the cost of servicing the debt which, in turn, adds to the deficit.

If the definition of insanity is doing the same thing over and over again and expecting different results, then why is the Fed’s monetary policy and the federal government's habit of increasing the debt ceiling going to fix anything? - Jesse

Fed policy and the debt ceiling are certainly related to the deficit debacle, but they’re not the problem. Fed policy is much more the result of the once-in-a-lifetime financial collapse of 2008.

The debt ceiling is a legal technicality: If your lender increases the limit on your credit card, you don’t owe any more money. The question is whether you have the discipline not to go out and spend it.

My own view is that there is a single cause underlying the debt crisis that is hitting the developed world: increased human longevity. When Social Security and Medicare were created, no one expected people to live as long as they do. That has made all state-funded health care and income security programs more expensive than when they were originally designed. But no politician will ever get elected on a platform of cutting these programs. None of us wants to give up the idea that these programs will be there when we’re old.

Related: 47 million Americans living in poverty

I thought we wanted to reduce the federal debt. Increasing taxes and cutting spending appears to be the correct method - why is it all of a sudden the wrong thing to do? Do we not have to start paying down the debt?

The most important measure of the debt isn’t its absolute size – it’s the size relative to the size of our economy. If you have credit card debt of $20,000 but you only earn $30,000, you’re in a lot worse shape than someone with the same size debt who earns twice as much.

But yes, we want to slow the growth of debt and get the economy (our national income) growing faster. The problem is if we try to do it all at once, the economy will slow down again. Tax hikes take money out of the larger economy. So do spending cuts - think of all the government contractors who pay salaries to their employees.

Once the economy gets back on track, it will be a lot easier to raise taxes and control spending because our overall national income will be higher.

Our monetary policy is directly related to the current fiscal crisis. If we hadn't abandoned the gold standard, the government wouldn't have got us to this point. Any chance we'll hear renewed talks of returning to some variation of gold standard? - Mike

If we could turn the clock back, oh, say 100 years, it might be possible for the U.S. dollar to be linked to gold. Today, you might as well ask everyone to throw away their cellphones. Forever.

Governments – no matter how big – can’t fix the price of a commodity that is bought and sold second-by-second on a global market. But even if ours could, there’s another much bigger problem. There’s simply not enough gold in the world to back the U.S. debt outstanding.

Click here for full story on the gold standard debate.

And here is the link to the full webchat:

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