Over fiscal cliff a slippery slope

If no deal is reached, the new year will bring with it financial pain for many Americans, writes Zachary Goldfarb.

This is what the other side of the "fiscal cliff" looks like. If President Barack Obama and Congress fail to reach a deal to avoid hundreds of billions of dollars of tax hikes and federal spending cuts, many Americans will feel the pain with less money in their payslip in the first week of the new year.

On Friday, January 4, middle-class Americans who get paid that day would see take-home pay decline by an average of about $US25 ($24), according to calculations based on data from the non-partisan Tax Policy Centre.

That's the effect of higher taxes on just under one week of pay in a bimonthly cheque. In wealthy areas such as Washington, the average tax hike for someone earning more than $US100,000 would be $US130, reflecting higher taxes on nearly one week of pay.

The tax hikes would result from the expiration of the payroll tax holiday, which has been in effect for two years, and tax cuts by the Bush administration, which have been in effect for a decade. The impact in the first week would be modest. The following weeks would be much uglier.

"It's going to be a gradually increasing wave of anxiety that's going to go over people day by day in January," said Steve Bell, senior director of economic policy at the Bipartisan Policy Centre and a former member of the Senate budget staff.

In the second week of January, about 2 million jobless Americans who have been relying on federal unemployment insurance would stop receiving cheques.

This would be likely to have an immediate effect on the overall economy. People receiving unemployment benefits usually spend almost all the money on necessities such as food, toilet paper and toothpaste, economists say.

Then, on Friday, January 11, Americans who get paid that day would take an even steeper hit. The average middle-class employee, having worked nearly two weeks in 2013, would see the take-home pay in their bimonthly payslip decline by about $US60, according to the Tax Policy Centre. (For two full weeks, the figure would be about $US65.) Wealthier Americans could see their take-home pay fall by an average of $US290. Over the following weeks, the initial distress would build into something even worse. Financial markets could be in panic. But even if they're not, this is how the so-called fiscal cliff turns into fiscal chaos.

If an agreement continues to elude the White House and lawmakers, doctors who accept Medicare, the health insurance program for the elderly, will see their reimbursement rates automatically slashed. As April 15 approached, millions in the middle class would be on the hook for taxes they didn't know they would have to pay. Federal agencies may have to furlough workers. And the federal government could run out of money, potentially defaulting on the national debt.

This seems an unlikely scenario. But after a month of fitful talks, Obama and congressional Republicans have been unable to reach an agreement. House Speaker, Republican John Boehner, gave the negotiations a boost when he agreed to raising tax rates on millionaires in exchange for deep cuts in entitlement programs such as Medicare. Time is fast running out to avoid the cliff - and a blow to the US economy that could knock it back into recession - and President Obama is expected to cancel his annual trip to Hawaii for Christmas to keep negotiating in Washington.

The two sides have less than two weeks before the deadline. If the country steps over for just a few days and then a deal is cinched, the impact would be modest, economists and budget analysts say. Treasury officials in the past have tentatively concluded that they have the ability to freeze payroll withholding tables if there is a high probability that lawmakers will strike a deal soon after the deadline, but officials have discounted the idea this time around. By contrast, a prolonged period without a deal would invite protracted pain.

Working Americans would continue to see smaller payslips. Jobless Americans would continue to go without unemployment insurance.

Meanwhile, hundreds of thousands of doctors who care for elderly patients would see their payments shrink by about 30 per cent. Each year since 1997, when a law intended to slow healthcare spending was enacted, Congress has voted to temporarily boost payments to doctors. If Congress does not act, the payments would reset to a much lower figure. This year, the "fix" is tangled up with negotiations on the fiscal cliff.

While the lower reimbursement would technically kick in on January 1, Medicare is expected to be able to postpone the reduction in reimbursements for about two weeks, according to people familiar with the matter.

Then, as middle-class Americans begin to file their tax returns in late January and February they would have a rude awakening. Millions would find themselves subject, for the first time, to the alternative minimum tax, designed to ensure that wealthier Americans do not use deductions to avoid paying the basic minimum in taxes. But because of the way the that tax is structured, it would also affect millions of middle-class Americans - unless Congress "patches" it, which it has done every year.

In a recent letter to Sander Levin, ranking Democrat on the House Ways and Means Committee, the acting Internal Revenue Service Commissioner Steve Miller said that if the alternative minimum tax is not patched, 60 million taxpayers may not be able to file their tax returns or receive refunds until the IRS overhauls its systems.

"Because of the magnitude and complexity of the changes, it is entirely possible that these taxpayers would not be able to file until late March 2013, if not even later," he wrote. "Tens of millions of these taxpayers would unexpectedly have to pay additional income tax for 2012, leaving them with a balance due return or a much smaller refund than expected. For millions of other taxpayers, refunds would be delayed."

(Americans, particularly the rich, will also have to grapple with other tax increases, such as those on investment income.)

As Americans deal with exasperating tax changes, federal agencies would begin carrying out tens of billions of dollars in spending cuts.

In the first week of January, the White House would submit a report to Congress detailing line by line how much each department and program would be cut. The government would not look dramatically different - for a few weeks. Most agencies would continue spending, but with caution, likely eliminating travel and training and slowing or halting hiring.

"The first week, we kick the can down the road," said Carolyn Federoff, a lawyer for the Department of Housing and Urban Development and official with the American Federation of Government Employees. "We pretend like there's going to be a solution, so we don't have to really implement the cuts yet."

Furloughs, particularly at agencies where labour costs make up most of the budget, would be weeks, if not months, away. But the planning for them would need to start almost immediately. Public employee unions plan to call for bargaining over the terms of unpaid days, whether they're staggered over numerous pay periods or more concentrated.

A potentially fateful challenge would probably come in late February or early March, when several federal budget analysts expect the Treasury to run out of borrowing authority. Treasury is technically supposed to rub up against the debt limit at the end of this month, but the agency can tap other sources of funds, such as civil service pensions, to extend the deadline for several weeks.

But that flexibility could be exhausted in late winter in the US, confronting the country with the prospect of a government default as happened in 2011. Back then, Treasury examined a range of options to delay the deadline even more, from selling the country's gold stockpile to paying only some federal bills, according to an August report by Treasury's inspector-general.

At the time, Treasury officials concluded that the best option, if they ran out of borrowing authority, was to hold back on all of a given day's payments until they had enough money in federal coffers to write cheques to meet all obligations for that day. (Even if it can't borrow money, Treasury receives tax revenue almost every day.)

"Treasury reached the same conclusion that other administrations had reached about these options," the inspector-general wrote. "None of them could reasonably protect the full faith and credit of the US, the American economy, or individual citizens from very serious harm."