Fiscal Cliff Deal: ‘A Missed Opportunity’

While the fiscal cliff deal that was approved by the House and Senate on Jan. 1 was good news in that it sent the markets soaring and includes some changes that make financial planning easier, critics of the deal say that it fails to remedy the fiscal challenges that lie ahead.

The legislation, H.R. 8—the Taxpayer Relief Act of 2012—was signed into law by President Obama and contains approximately $620 billion over 10 years in higher taxes, mostly falling on high-income earners. The bill was approved by the Senate by an 89 to 8 vote, with the House passing the measure the same day by a vote of 257 to 167.

The former co-chairmen of Obama’s debt commission—former Republican Sen. Alan Simpson and Democrat Erskine Bowles—bemoaned the cliff deal in early January as a “missed opportunity.”

The deal “is truly a missed opportunity to do something big to reduce our long-term fiscal problems” and is only “a small step forward in our efforts to reduce the federal deficit,” Bowles and Simpson said in a joint statement issued after the deal was struck.

Andy Friedman, principal of the Washington Update, said the compromise leaves Congress with “three forcing events” in the first quarter. “First, the United States has hit its debt limit, and that ceiling must be raised to permit the country to continue to borrow. Second, the implementation of the sequestration spending cuts is delayed only until March 1. And finally, on March 31, the federal government will shut down unless Congress appropriates additional funds,” he said.

To address those “forcing events,” Friedman said that Republicans “will demand more spending cuts, and it is no longer possible to meet those demands simply by cutting discretionary spending.” Democrats, on the other hand, “will demand that the spending cuts be balanced with more tax increases, and it is no longer possible to meet those demands simply by raising tax rates. That means we are heading for a debate over entitlement reform and tax reform.”

According to Friedman, the areas at “most risk” as lawmakers attempt to address those events include “some or all” of the following changes:

• Limits on tax exemptions and itemized deductions for affluent families
• An additional limitation on the deduction of mortgage interest
• Taxing gains from sales of carried interests in investment partnerships as ordinary income
• Curtailing sophisticated wealth transfer techniques
• An increase in the retirement age for Social Security and Medicare benefits, and a change to the manner in which the annual increase in benefits is calculated

While a number of GOP lawmakers voted to pass the bill and boost taxes on the wealthy, Sen. Richard Shelby, R-Ala., ranking minority member on the Senate Banking Committee, told Fox Business that passing the legislation was “a mistake.” 

Noting that he would have preferred a “grand bargain,” Shelby (left) said Obama rushed a bill so the country wouldn’t fall into recession. He said the legislation ultimately does little to cut spending. While the nation needs comprehensive tax reform, “We also need to look at entitlement reform, and we need to look at the spending ledger; we’re always wanting to spend and promise and spend and borrow, but not cut,” Shelby said.

The legislation extends the majority of tax cuts that were scheduled to expire at the end of 2012, as well as retroactively reinstates some rules that expired in 2011, noted Michael Kitces in his Nerd’s Eye View blog, published on Jan. 1. Kitces wrote that the bill introduces a number of new changes: a new top tax bracket of 39.6%, and an increase in the top long-term capital gains and qualified dividend rate to 20%. Some old rules that had lapsed and were scheduled to come back have in fact returned, Kitces pointed out, such as the Pease limitation (a phaseout of itemized deductions) and the Personal Exemption Phaseout (PEP).

In addition, the legislation sets out a new rule allowing 401(k) participants to complete intra-plan Roth conversions if the employer offers designated Roth accounts under the plan, regardless of whether the individual is allowed to take a distribution out of the plan, Kitces said. The transaction, he said, will be taxed in a similar manner to any other Roth conversion.