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A Fiscal Cliff Resolution? Not Really

 January 03, 2013 09:48 AM


(By Mani) Now that Congress and the president have agreed to a deal that addresses part of the fiscal cliff, the attention will shift to the next major milestone: the need to raise the debt ceiling. The compromise addresses both taxes and, to a lesser extent, spending cuts of the fiscal cliff. However, there is no long-run resolution.

At the end of the two-month window, the nation will again face the need to raise the debt limit, which sets the stage for the next major debate over government spending cuts and the future path of federal spending.

While a major blow to the economy has been averted through the extension of most of the tax cuts and some of the spending reductions, economic growth would remain slow in the first quarter.

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"The package passed was largely in line with our expectations, and thus, we continue to expect growth in the one percent range in the first quarter. We expect another contentious political debate over the future of both tax and spending policy when the debt ceiling debate begins shortly after the new Congress is in place," Wells Fargo economist John Silvia wrote in a note to clients.

This debate will re-introduce uncertainty to financial markets and will likely weigh on business and consumer confidence.

On the tax side, the top income tax rate will rise, as well as taxes on capital gains and dividends, for individuals making more than $400,000 per year and families making more than $450,000 per year. Several tax credits have been extended for five years, including the higher education tax credit. A permanent patch for the Alternative Minimum Tax (AMT) is also included to prevent middle-income brackets from being subject to the AMT.

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The estate tax would increase for individual estates over $5 million and family estates over $10 million. As expected, the 2 percent payroll tax cut will be allowed to expire as scheduled. With regard to corporate taxes, accelerated or "bonus" deprecation of 50 percent is extended for one year, along with tax credits for research and development costs.

On the spending side, long-term unemployment benefits will be extended for another year, and the patch to prevent a reduction in payments to Medicare providers was extended for one year. The spending component of the bill also defers the scheduled automatic budget cuts for two months. The net cost over the 10-year horizon could add nearly $4 trillion to the federal deficit compared to what would have occurred if all of the tax and spending cuts were allowed to go into place.

"The deal this week to avert the fiscal cliff provides some clarity to individuals and business decision makers; however, the relief may be temporary. What the deal does not include is how the process of automatic budget cuts, known as sequestration, will be addressed beyond the two-month deferral," Silvia said.

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