What, Me Worry About the Fiscal Cliff?

      A few weeks ago I wrote a piece about the fiscal cliff for the U. S. News retirement site. I saw that the so-called "fiscal cliff" was on the horizon and thought people should know about it. But in all honesty, I figured that the fiscal cliff was kind of a manufactured crisis and that it would go the way of Y-2K after the election was decided and politicians in Washington came to their senses.

     Now I'm not so sure. Perhaps I'm giving people in Washington too much credit.

     The term "fiscal cliff" is shorthand for a series of federal spending cuts and tax hikes that will automatically go into effect in January, if Congress and the President don't get together and act to override them. The measures originated in Congress last year as part of a compromise to pass the Budget Control Act of 2011.

     The tax hikes include ending the temporary reduction in the payroll tax (which funds Social Security), ending some tax breaks for businesses, changing the alternative minimum tax and inaugurating some taxes to start paying for the Affordable Care Act. They will also affect certain tax credits for college tuition and low-income families. 

     At the same time, the White House has detailed a whole list of budget cuts that will affect over 1,000 government programs, including $55 billion in defense cuts and $11 billion in lower Medicare payments.

     The fiscal cliff presents a giant air pocket for the entire economy. But there are a few ways in which it would affect us seniors in particular.

  

     For example, if you rely on stock or mutual fund dividends to help fund your retirement, you can expect to take a "pay cut," as those dividends, currently taxed at maximum rate of 15%, will be taxed at ordinary income rates, up to about 40%.

     Do you have any capital gains on investments you might have made five or ten or twenty years ago? Again, the tax rate would go up on them. The maximum tax rate on long-term capital gains (investments held longer than a year) will increase from 15% to 20%. Meaning, again, if you plan to cash in some investments to help fund your retirement, you will be forced to take a pay cut.

     And if you do own any investments, either in your IRA or elsewhere, the value of those assets will likely go down. In theory, the value of an investment consists of the after-tax sum of all future returns. If as most experts predict, the economy suffers after going over the fiscal cliff, then those returns will be lower. And to add insult to injury, those lower returns will be taxed at a higher rate.

     It only makes sense that the stock market, as well as private business investments, would deflate to a lower level. High-dividend stocks, defense stocks and banking stocks might be the biggest losers. But even more stable investments in health care, energy and agriculture would probably be a bad bet, since going over the fiscal cliff would leave everyone black and blue.

     And then there's your home. No one knows how the fiscal cliff will influence mortgage rates. But with less government spending, less employment, less after-tax income, and a less robust economy in general, it's hard to see home prices rebounding in any meaningful way. In fact, the fiscal cliff could rachet down value of your house yet again, as funds are squeezed out of the housing market to shore up the rest of the economy.

     And if all this isn't enough, there are the cutbacks. The government spends a lot of money, and if it spends less, then there will be across-the-board cutbacks to government programs, bringing hardships to beneficiaries as well as lower revenues to the thousands of companies that do business with the government.

     More particularly, the fiscal cliff aims to cut some $11 billion out of Medicare, in part by lowering payments to doctors. This could mean individual patients will have to pay the difference. Alternatively, it could put cost pressures on medical facilities, forcing them to reduce staff. Lower payments could also lead doctors to limit the number of Medicare patients they will see. The fiscal cliff could make it harder for some people to find a doctor, and could mean longer wait times and lower quality of service for those who do.

     There is arguably one benefit to the fiscal cliff. Social Security. No, your benefit will not get any higher. But the fiscal cliff automatically ends the 2% payroll tax "holiday" enacted under President Obama in 2010. Since the payroll tax funds Social Security, restoring the higher tax rate will repair some of the damage done to the funding of the program.

     But is that worth all the other pain and suffering that will be brought to you by the fiscal cliff? I doubt it.

      To be sure, there's no reason why Congress couldn't do both:  Reinstate the payroll tax to shore up Social Security and then also make some kind of deal to avoid all those other economic problems. But that would require them to grow up and act like adults. What are the chances of that? 

     P. S. To see what's currently going on in Congress, to witness all that your representatives are doing on your behalf, to view all the frenetic activity going on in Washington to save the situation, check out the Capitol webcam.