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The foreseeable effects of the fiscal cliff

December 10th 2012

Till November 6th the hottest conversation subject for Americans everywhere had been the presidential race. Now that people know who is going to be sitting in the Oval Office for the next 4 years, the bit of news that America is currently obsessed with is the so called fiscal cliff.

Like the presidential race, the fiscal cliff is just as important minus all the unnecessary media overexposure. Moreover, it is of immediate importance as the clock ticks towards the 31st of December, 2012, the day after which some analysts and economists have theorized that America might be headed towards another financial crisis.

How was the fiscal cliff born?

In 2011, the Congress reached a census whereby tax rates and certain other sources of Federal revenues were adjusted in order to modify the debt ceiling. The resolutions and Acts passed in order to put the measures into effect were signed into law with an expiry date of December 31st 2012.

Unless Congress is able to reach a consensus again before the end of the year and manage to find a way out of the problem, the sudden financial drain on the American economy as a result of higher taxes on middle income groups and loss of federal backing for businesses, is going to push the country off this ‘fiscal cliff’ and down towards another recession.

So how is the fiscal cliff going to affect the people at large? Here are a few foreseeable scenarios.

Higher taxes

Although the US is one of the countries with a relatively low income tax rate, the condition of the economy is such that more than 53 percent of Americans would feel the burn pretty badly if taxes were to go up. The current tax brackets read starts at a low 10 percent and the maximum is set at 35 percent. Unless the government can bring in a suitable tax plan and the clock is allowed to reset on the 31st of December, the lowest income tax rate would be reset to 15 percent. In other words, middle income families are likely to pay almost $2000 extra per year.

Higher tax on investments

The tax cuts introduced during the Bush administration also lowered the rate of taxation on investments. Once they expire on the 31st of December, tax rates applicable for long term capital gains are going to up from 15 to 20 percent. Moreover, individual marginal tax rates would become applicable on qualified dividend instead of the currently fixed 15 percent. This is one of the main reasons why retail investors, senior citizens or anybody for that matter who withdraws from brokerage accounts and qualified retirements plans like Roth IRAs.

Increased unemployment rates

The current unemployment rate is about 7.9 percent as of October 2012 which is significantly better than what it was (10 percent) during the same period in 2009. Analysts and economists believe that nearly 3.4 million people would be faced with unemployment and job loss after the 31st of December which would be triggered by budgetary cuts slowing economic growth. The national unemployment figures may go up as high as 9.1 percent.

Reduced tax exemptions and benefit cuts

As of 2012, amounts up to $5.12 million were exempt from estate and gift taxes and anything above is taxed at 35 percent. After the end of the year, the exemption ceiling will drop to a low $1 million and anything above it will be taxed at the rate of 55 percent.

As a result of the 2008 financial meltdown, the Federal government provided extensions on benefits to the unemployed who had already eaten up their state allowed benefits. The program is set to expire at the end of the year and as a direct result, an estimated 2 million Americans are going to be affected with another 1 million following suit in April of the next year.

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