Organizing Your Money in 2013 in Light of the “Fiscal Cliff” Deal

The “fiscal cliff” has come and gone and visits us again as we negotiate the “debt ceiling.” Sadly, I don’t think most people have any idea how to even begin to understand these issues. To really participate in the discussion, you need to understand tax law and for most people that is about as interesting as watching paint dry.

To drum up interest in the issue, all the news was telling us was horror stories about increased taxes. But our tax system is so complicated that there is no way to know without hours of calculations what any particular tax change REALLY means for any individual person or family. The Democratic party began circulating the figure of a $2,000 tax increase for the typical family. There was no real explanation of where that number came from and even if there was an explanation, who would understand it?

And so, at the last-minute, we had the fiscal cliff deal but what was it?

For a lawyer, all of this vagueness is maddening. You can’t mention increased taxes without getting really specific. And so, I present to you, my attempt to summarize what I think happened with tax rates both before and after the fiscal cliff. (Note: the tax code is so complex that I am not 100% sure I have this right. If you have a correction, please email me or post a comment.)

As you can see, the fiscal cliff deal increased taxes on only a very tiny fraction of all taxpayers (roughly only the top 3% of all taxpayers). But if you happen to be in this “lucky” group, thank you for “agreeing” to pay roughly a 5% increase in your overall taxes.

But what I find the most interesting is that the fiscal cliff really didn’t have much of an effect at all on the bulk of all taxpayers. Approximately 77% of all taxpayers earn less than $75,000 per year. Approximately 38% fall somewhere in the $17,400 to $70,700 income band (highlighted in yellow). These taxpayers didn’t really benefit from the Bush tax cuts since their taxes and dividend taxes have been the same. These taxpayers likewise didn’t face any threat from the fiscal cliff. So, if you want an explanation for voter apathy on this issue, you might have it there. I also find it interesting that no one was up in arms about the 5% tax increase on those earning less than $17,400. If there was one fiscal cliff tax rate increase that seemed bizarre and wrong, that one was a standout.

So, if there wasn’t much change on tax rates for most people, how else did people “save” money during the recent fiscal cliff deal?

For a lot of families, a cut of 50% to the child tax credit would be a big impact on their taxes. Yet, you heard nothing about this particular issue in the news. Likewise, the marriage penalty was not mentioned. I find it also strange to know that the estate tax exemption is now even higher than it was before the fiscal cliff, an odd result to be sure.

If you have received your first paycheck of 2013, you may have noticed that despite the avoidance of income tax rate increases, your pay may be up to $189/month lower than expected. This is, of course due to the resumption of “normal” Social Security taxes.

I personally don’t mind this increase as I think anyone who ever hopes to claim Social Security one day needs to pay in. We know this program is underfunded so it only makes sense to me to resume the old tax rates. We also see that higher income earners are going to start chipping in more to Social Security and Medicare.

If you take the perspective as I do that we need to start making meaningful progress in rectifying the nation’s finances, the fiscal cliff deal is hardly inspiring. Yes, we need to be careful not to kill the economy but honestly, we can all afford to take a few more hits for the sake of the country. I am shocked at the lack of creativity in creating these deals. For example, it is not as though the only choices were keeping the Bush tax cuts or raising them back to Clinton-era rates. We could have raised taxes 1% on everyone or even 0.5% and most people would not have noticed. The child tax credit could have been cut by $100 or $50 as a token of solidarity. As we head toward the debt ceiling negotiation, I hope we see a little more bravery and creativity.

What do you make of the fiscal cliff deal? Please share in the comments.