The Fiscal Cliff: Who Has the Most to Lose If We Fall Off

Barack Obama and Mitt Romney
Barack Obama and Mitt Romney

On Tuesday night, President Obama and former Massachusetts Gov. Mitt Romney will meet for their second debate. The bout over foreign and domestic policy should be an interesting engagement: Romney hopes to consolidate his gains from the first debate, while the president hopes to make up some of the ground he lost.

But beyond the land of debate prep, the political arena is getting hotter. The "fiscal cliff" -- a pending economic catastrophe that is haunting the election -- is drawing closer, and pundits have already begun talking about the specific ways in which it will hit the economy. The Tax Policy Center has announced that, if we hurtle over the fiscal cliff, the average middle class family would pay an additional $1,984 in taxes in 2013.

The number brings to mind George Orwell, the patron saint of political satire; 1984, after all, is the title of Orwell's famous novel of bureaucratic evil run amok. But today, just as in Orwell's dystopia, the most important thing isn't what is being said, but what is not. Because, while the $1,984 sum is impressive, it hides the true cost of the fiscal cliff, a precipice that will punish all families, but some more than others.

Yes, the average middle-class family will pay $1,984 more, but the fiscal cliff will cost the average family overall $3,446, almost twice as much. The huge gap between those two numbers reveals the wide difference between middle class and upper class tax breaks -- and hints at the grand class battle that awaits Washington after November's elections.

He Who Controls the Purse Controls the Future

The definition of "middle class" varies greatly depending on who is talking, but strictly by the income numbers, the third quintile is the middlest of the middle. Households within this 20% of the populace make between $38,521 and $62,434 per year, and average $50,477. At that level, a tax increase of $1,984 works out to another 3.8% of every paycheck that goes to the taxman.

The average family, though, will kick in an extra $3,446, because -- in terms of straight percentages -- the tax increases will hit families higher up the income ladder much harder than those in the middle or at the bottom. And that massively skews the average.

In this regard, the fiscal cliff is somewhat progressive, landing harder upon the rich. For families in the first four quintiles -- groups that could be described as "poor," "working class," "middle class," and "upper middle class," the potential fiscal cliff tax increase percentages range from 3.7% to 4.2%. For the richest 20% of households, however, the tax increase would a far steeper 5.8%.

All Taxpayers Are Equal ... But Some Are More Equal Than Others

A large factor in this uneven impact relates to which specific tax breaks will expire if we reach the fiscal cliff. While analysts tend to lump all these tax changes together to simplify to discussion, the issues in play are actually a widely disparate collection of specific tax deals that unevenly benefit various groups. The payroll tax cut, for example, is most beneficial for households making less than $110,000 per year. Others, like the Bush tax cuts, benefit all income groups, but pay off more for the wealthy.

Sponsored Links

And then there are the tax breaks that specifically benefit the wealthiest taxpayers; as it stands, many of these will disappear on Jan. 1, 2013. Perhaps the most obvious is the estate tax. In 2009, the first $3.5 million of an estate was untaxed, and the remainder was taxed at a top rate of 45%. The following year, the tax was zeroed out, effectively granting a tax holiday to wealthy families whose members died. When the tax returned in 2011, the "exclusion amount" rose to $5 million -- and later to $5.12 million in 2012 -- while the top rate on amounts exceeding that dropped to 35%. In 2013, assuming the fiscal cliff comes to pass, the exclusion amount will fall to $1 million and the top rate will rise to 55%.

Even at this new, much lower level, the estate tax will only hit 2% of those who die in 2013.
So for middle and lower-class families, this change will be academic, but for households at the top of the pyramid, it will hit hard.

The same is true of the Bush's 2001 high-income tax cuts and the preferential capital gains and dividend tax rates that he pushed through in 2003. Combined with other tax increases, the repeal of these tax breaks will cost the richest 20% of families an average of $14,173 each. For taxpayers in the top 1%, the cost rises to just over $120,000 -- or more than 7% of their income.

Ultimately, both parties are hoping that the November elections will give them an edge in the fiscal cliff fight -- and until Nov. 7, it's impossible to predict the shape of the deal that will (we hope) be struck by the president, the House of Representatives and the Senate.

Regardless of what happens in Washington's version of Animal Farm, however, one thing is clear: When it comes to taxes and the fiscal cliff, the richest Americans have a lot more to lose than the rest of us -- a fact that their highly-paid lobbyists in Washington are sure to have in mind come December.

%Gallery-167011%


Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.

Related Articles



Your resource on tax filing
Tax season is here! Check out the Tax Center on AOL Finance for all the tips and tools you need to maximize your return.
Child Tax Credit Calculator and Top 7 Requirements
The Child Tax Credit can significantly reduce your tax bill if you meet all seven requirements: 1. age, 2. relationship, 3. support, 4. dependent status, 5. citizenship, 6. length of residency and 7. family income. You and/or your child must pass all seven to claim this tax credit.
Read MoreBrought to you byTurboTax.com
7 Smart Ways to Invest Your Tax Refund
You can maximize your tax refund in several ways — from paying off high-interest debt to investing in a business or saving for retirement. One or more of these options could be the perfect fit for you.
Read MoreBrought to you byTurboTax.com
How to Pay Taxes: 10 Ways to Pay Your Tax Bill
You know you owe taxes, but you may not be aware of all the available options for getting that money to the IRS.
Read MoreBrought to you byTurboTax.com
Taxes 2021: 7 Upcoming Tax Law Changes
Tax Year 2021 will likely bring some surprises, but some of its changes are already planned. Here's what you need to know about some of the planned phase-outs, changes and inflation adjustments the IRS will present for taxes in 2021.
Read MoreBrought to you byTurboTax.com