The winners and losers of last night’s fiscal cliff deal

By John Shmuel

In case you were asleep when it happened, the U.S. House of Representatives finally reached an agreement late last night to steer the country out of the dreaded “fiscal cliff.”

The bill, which prevents the United States from being hit with a set of tax increases and spending cuts simultaneously this month, passed in the House in a bipartisan 257-167 vote.

Of course, many are wondering what exactly the hefty 150-page bill means and what it does. But don’t worry. Derek Holt, Scotiabank’s vice-president of economics, has a handy breakdown of what last night’s legislation actually does.

Here’s a look at his explanation, which looks at who the bill hurts, who it benefits, and what remains to be seen.

WHO IT HURTS

1. The 2% social security payroll tax cut to the workers’ share is gone permanently. As a consequence, disposable income will decline in January and Q1. By how much? Up to about $2,400 annually for those with earnings at the 2013 cap of $113,700 or more. Just under half that for the roughly average family. This measure is generally thought to knock about a half point off of annual GDP growth and is likely to hit consumption in Q1-Q2. It never really achieved the desired positive impact upon job creation. The hike is also likely to weigh upon consumer confidence through assessments of present conditions when lower after-tax paycheques are realized.

2. Upper income earners (individuals earning over $400k and joint filers over $450k) face a permanent hike in their marginal tax rate to 39.6%. President Obama has remarked that further increases will be sought as part of additional negotiations in 2013 to reduce spending and raise revenues. Thus, we cannot yet evaluate the full tax implications for upper income earners.

3. For the same definitions of upper income earners, taxes permanently rise on capital gains and dividends from 15% previously to 20% now. Those below the income thresholds will pay a permanently capped 15% rate except for lower income earners that pay nothing.

4. The top estate and gift tax rate will rise to 40% from 35% previously for those above the exemption. The estate and gift tax exemptions will remain at $5 million or more per individual (not the $3.5 million at a 45% rate that the White House sought).

5. Tax refunds for early filers will be delayed as the tax filing season will be delayed by several weeks. That will push income out of the early months of 2013 into ensuing months. As a consequence, seasonal adjustment factors for income will be distorted for months and it may take until Q2 before we get cleaner data to evaluate trend income growth.

6. Personal exemptions and itemized deductions will be capped for individuals earning over $250k and couples earning over $300k. This is a permanent restoration of the Personal Exemption phase-out, or Pease provision after the late Donald Pease (Democrat). The formula based approach is thought to add just over 1% to the highest marginal tax rate.

7. 401(k) plans will be rolled into Roth IRA plans and hence taxes will have to be paid up front on gains in the plan. The carrot is that pay-outs from Roth plans are not taxed. Roth plans offer no tax deductions on contributions but shelter investment income upon distribution. They contrast with 401(k) plans that offer deductions on contributions, but then tax investment income flows upon withdrawal. Washington’s move therefore captures higher near term tax revenues at the expense of longer term tax revenues as baby boomers retire. It is likely a relatively short-sighted near term revenue grab that fits the pattern of kicking the can down the road.

8. A pay freeze for members of Congress has been extended for another year. A freeze on pay for federal government workers has been allowed to expire.

WHAT WILL HELP

1. Those earning up to $400k/$450k individual/household income will have the Bush era tax cuts permanently extended. This is not added stimulus, but averts a tax hike for 99% of filers. Some may question whether permanent extensions represent good policy for a heavily indebted government running enormous long-term deficits and I wouldn’t be surprised to see ‘permanent’ being revisited in future.

2. The broadening of the alternative minimum tax in 2013 would no longer occur.

3. Depreciation incentives for businesses to write off up to 50% of equipment spending will be extended for another year. This is a plus for business investment, but it requires confidence for its effects to be unleashed and that isn’t likely until later in the year.

4. Unemployment insurance benefits that were lengthened in the crisis would be extended for another year at a CBO estimated cost of $30 billion. We’ll be having that portion of the debate again by late 2013. At nearly two years, the US offers as generous jobless insurance as the most liberal of European economies.

5. Other miscellaneous tax measures (deductions for teachers, charitable donations, state sales taxes) will be extended for varying periods with retroactive extensions for provisions that expired in early 2012. The American Opportunity Tax Credit is extended for five years, as is the Child Tax Credit and Earned Income Tax Credit.

6. A scheduled cut in Medicare payments to doctors will be delayed a year.

7. At least for now, the GOP fully backed away from efforts toward using chained CPI indexing of entitlement spending which would have represented cost savings to the government.

WHAT REMAINS TO BE ADDRESSED

There is no agreement on the debt ceiling which has now been surpassed. A large risk facing the US economy is how $110 billion in spending cuts that have now been delayed for two months in this agreement will be tied to an increase in the debt ceiling that will be required by February or March after the Treasury takes extraordinary measures to postpone the ceiling’s binding effects. This will be a significant concern to markets for some time as this mini-deal fails to address the spending and borrowing sides of the picture. It may be that the GOP waved the white flag on the first leg of the negotiations, only to gain leverage in their quest for spending cuts by an administration that is thus far demonstrating little concern for the fiscal position of the United States.