Even though U.S. lawmakers have avoided the so-called fiscal cliff, higher taxes and brinksmanship in Washington are likely to continue damaging the fragile economy well into 2013.
In the early hours of the new year, the Senate passed emergency legislation to prevent deep spending cuts and even bigger tax hikes from taking effect. But the measure ran into fierce opposition Tuesday from House Republicans, before they finally agreed to support it in a late-night vote.
The deal raises taxes on individual incomes over $400,000 and household incomes over $450,000 and on the portion of estates that exceeds $5 million.
The higher taxes on the wealthy would likely slow the economy a little bit. But a bigger drag would come from a tax hike Democrats and Republicans aren’t even bothering to fight over: the end of a two-year Social Security tax cut. The so-called payroll tax is scheduled to bounce back up to 6.2 percent this year from 4.2 percent in 2011 and 2012, amounting to a $1,000 tax increase for someone earning $50,000 a year.
“It’s a huge hit,” says Joel Naroff, president of Naroff Economic Advisors. “It hits people whether they’re making $10,000 or they’re making $2 million. It doesn’t matter who you are ... The lower your income, the more of your income you’re (spending). So if you’re taxes go up, it’s going to come out of your spending.” And that is bad news for an economy that is 70 percent consumer spending.
Mark Zandi, chief economist at Moody’s Analytics, calculates that the higher payroll tax will reduce economic growth by 0.6 percentage points in 2013. The other possible tax increases — including higher taxes on household incomes above $450,000 a year — will slice just 0.15 percentage points off annual growth, Zandi said.
The economy doesn’t have much growth to give. Mark Vitner, senior economist at Wells Fargo, predicts it will expand just 1.5 percent in 2013, down from a lackluster 2.2 percent in 2012. Unemployment stands at 7.7 percent.
A months-long political standoff over fiscal policy has already taken its toll, adding uncertainty that has discouraged consumers from spending and businesses from hiring and investing.
Senators postponed tough decisions on government spending, giving themselves a reprieve from cuts that were scheduled to begin taking effect automatically Tuesday. That just sets the stage for more hard-bargaining later, even if the House approves the Senate’s version.
And another standoff is likely to arrive as early as February when Congress will need to raise the $16.4 trillion federal borrowing limit so the government can keep paying its bills.