Tax Tsunami

tax tsunami

While most of the world is focused on presidential politics, the bureaucrats in Washington are gearing up for next year’s huge tax increase. Given our wacky political climate, it is unclear how this will all turn out, but unless Congress acts, the New Year will ring in a full-blown tsunami of automatic tax hikes.

The Congressional Budget Office (CBO) projects that expiring Bush-era tax cuts and new Obamacare taxes will flood government coffers with an additional $399 billion in tax revenue in fiscal year 2013[1]. On a calendar year basis, the 2013 increase will be closer to $530 billion. The Heritage Foundations’ Curtis Dubay estimates that the average tax-paying household will see their tax bill increase by $3,800[2]. (See below for a breakdown of some of the major tax changes.)

For an economy still battling subpar growth, this tax tsunami is most dangerous. According to Lori Montgomery at the Washington Post, the potential shock of the tax increase is so huge some congressional staffers have dubbed it “taxmageddon.”[3] The hit from tax hikes is compounded further by automatic spending cuts that kick in next year. The CBO estimates the combination of tax hikes and spending cuts will reduce the federal budget deficit of 5.1%--a tectonic shift in fiscal policy that the CBO says will likely push our fragile economy back into recession during the first half of 2013[4].

While we applaud efforts to reduce the deficit, we should do it wisely. What is the benefit of fixing the economy’s engine if we then go and drive it off what Ben Bernanke calls a “massive fiscal cliff?” We would do much better to hold the line on spending, implement pro-growth tax policies and then allow the economy’s accelerating growth to dig us out of the deficit.

Unfortunately, implementing sound economic policy can be very difficult. The best metaphor I can find for modern American politics is Dr. Dolittle’s Pushmi-pullyu—the bizarre two-headed beast. Whenever it tried to go anywhere, both heads pulled in the opposite direction. Hopefully, our leaders will get their heads on straight and pull together before the tax tsunami hits.

Major tax changes coming in 2013

If you are in the upper tax brackets, here are some of the increases you will experience in your tax rates in 2013:

  • Long-term capital gains tax rates will increase from 15% to 20%.
  • The maximum tax rate on qualified dividends will increase from 15% to 39.6%.
  • The maximum tax rate on ordinary income including salaries, retirement plan distributions, and short-term capital gains will increase from 35% to 39.6%.
  • An additional 3.8% Medicare Hospital insurance tax will be levied on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over $250,000 for married taxpayers filing jointly, $125,000 for married filing separately, and $200,000 for individual returns.
  • There will be an additional Hospital Insurance tax of 0.9% on earned income above $250,000 for married taxpayers filing jointly, $125,000 for married filing separately, and $200,000 for individual returns.
  • The personal exemption and itemized deductions will begin phasing-out for adjusted gross income greater than $261,650 for married taxpayers filing jointly.
  • Estate and gift tax rates will revert to 2001 levels. The exemption will drop from $5.1 million to $1.0 million, and the portability of the deceased spouse’s estate tax exemption will disappear.
  • Millions more taxpayers will be subject to the Alternative Minimum Tax (AMT).

[1] Congressional Budget Office, Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013. May 2012. (http://www.cbo.gov/sites/default/files/cbofiles/attachments/FiscalRestraint_0.pdf)

[2] Curtis S. Dubay, Tax Day 2012: Taxmageddon on the Horizon. 16 April 2012. http://blog.heritage.org/2012/04/16/tax-day-2012-taxmageddon-on-the-horizon/ (accessed 5/31/2012)

[3] Lori Montgomery, “Taxmageddon’ looms at end of payroll tax holiday,” Washington Post, Feb. 18, 2012 (http://www.washingtonpost.com/business/economy/end-of-payroll-tax-holiday-sets-up-harder-hit-for-taxpayers/2012/02/16/gIQAnxqTMR_story.html) (accessed 5/31/2012)

[4] Congressional Budget Office, Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013. May 2012. (http://www.cbo.gov/sites/default/files/cbofiles/attachments/FiscalRestraint_0.pdf)