US Fiscal Cliff 2013: Details of Bill

How We Avoided Falling Off the Fiscal Cliff in 2013

US Fiscal Cliff 2013
Congress did not allow the economy to fall off the fiscal cliff in 2013. (Credit: Getty Images)

On New Year's Day 2013, the House of Representatives approved a Senate bill that averted the fiscal cliff. Republicans were unhappy that there weren't more spending cuts. But at least an income tax hike was averted for most Americans. Here's what the new bill contained:

  1. The Bush tax cuts remained on incomes below the threshold. This threshold is $400,000 for individuals and $450,000 for married couples. Incomes at and above the threshold were taxed at the 39.6 percent tax rate that existed prior to the cuts.
  1. Capital gains and dividend taxes were raised from 15 percent to 20 percent for families at the threshold and above. Estate taxes were raised to 40 percent of estates above $5 million for those at and above the threshold.
  2. Congress ended the 2 percent payroll tax credit that had been part of the 2010 Obama tax cuts.
  3. The income level at which the alternative minimum tax kicks in was permanently raised so it didn't affect middle-income taxpayers. It was indexed for inflation so that Congress no longer had to patch it year after year.
  4. The extended unemployment benefits continued through 2014.
  5. Sequestration was postponed for two months. The spending cuts that Republicans wanted were folded into the Fiscal Year 2014 budget negotiations.

Other Provisions of the Bill

Congress extended some exemptions and deductions. These included the mortgage insurance premium through 2013 and the American opportunity tax credit through 2017.

These also permanently covered the earned income tax credit. It limited these exemptions for individuals earning more than $250,000 and for married couples earning $300,000. For details on these, see House Approves Taxpayer Relief Act.

The bill took action on other important points:

  • It prevented a 37 percent decline in Medicare payments to doctors.
  • It extended federal dairy subsidies through the end of FY 2013, preventing a hike in milk prices.
  • It excluded President Obama's proposed 0.5 percent pay raise for Congress.

Like most other legislation, the bill contained some last-minute riders to provide a hodgepodge of smaller tax exemptions for special interest groups. These ranged from tax breaks for NASCAR, Hollywood and AMTRAK. For more, see 10 Weirdest Parts of the Fiscal Cliff Deal.

What Made the Vote Possible

The country actually fell off the fiscal cliff for barely 24 hours. Since all Bush tax cuts expired, tea party Republicans technically couldn't be accused of raising taxes. Instead, they reinstated the tax cuts for incomes at $400,000 or less. They then instituted a smaller tax cut for incomes above that amount.

Congress wanted to vote on the measure before newly elected members took office that Thursday. This shifted the voting power more toward the Democrats, even though the House retained a Republican majority. 

The Disaster That Was Averted

The fiscal cliff refers to the devastating impact on the economy in 2013 if national leaders allowed four tax increases and two spending cuts to take place at the beginning of the year.

According to the Congressional Budget Office, $607 billion in government stimulus would have been removed from U.S. gross domestic product between January and September 2013. These dates correspond to the last nine months of the 2013 fiscal year.

Two-thirds of that ($339 billion) would have resulted from the following tax increases:

  1. Expiration of Bush tax cuts and the American Recovery and Reinvestment Act - $229 billion.
  2. Expiration of the 2 percent payroll tax holiday, part of the Obama tax cuts - $95 billion.
  3. Expiration of partial expensing of investment properties - $65 billion.
  4. Obamacare tax increases - $18 billion.

The rest would have come from the following reductions in federal spending:

  1. Sequestration (automatic budget cuts) - $65 billion.
  2. Expiration of extended unemployment benefits - $26 billion.
  1. Reduction in Medicare payments to doctors - $11 billion.
  2. Other, unspecified changes that reduced the deficit by another $105 billion.

Worst Case Scenario

The worst case scenario was that there was a real chance that nothing would be done. No elected official wanted to be responsible for allowing a recession. That's what the Congressional Budget Office predicted. It said that the economy would contract 1.3 percent for the first two quarters of 2013. 

Even though the CBO projected that the economy would recover by growing 2.3 percent in the second half of the year, it would have caused more unemployment. Meanwhile, it would have only reduced the deficit by $560 billion. That's because people who have been laid off pay less in taxes. This consequently translates to lower revenue for the government.

Best Case Scenario

The best case scenario would have been if Congress extended all tax cuts and kept spending at current levels. In that case, the economy would have grown 4.4 percent in 2013 according to the CBO. At that growth rate, job creation would rise and the unemployment rate would drop. That would eliminate the need for extended unemployment benefits as these are tied to above-average state unemployment rates. More income from wages means that tax revenue would rise and reduce the deficit and debt.

A healthy economy can grow its way out of a high debt-to-GDP ratio. The higher the GDP, the lower the ratio as long as spending doesn't increase. For proof, notice that the national debt by year keeps increasing. Even though the debt from World War II has never been paid off, it doesn't matter. Economic growth has since dwarfed it.

But it's highly unlikely that Congress would support this scenario. Way too many elected officials think that the federal debt is unsustainable at even a 90 percent debt-to-GDP ratio. (Source: "Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013," Congressional Budget Office, May 2012.) 

Find Out More About What Led to the 2013 Fiscal Cliff