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Are You Ready for Taxmaggedon?

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A combination of spending cuts and tax increases could bring the economy to its knees at the end of 2012. If Congress and the president fail to act before then, nine significant fiscal events will automatically be triggered under current law. Together these events create a perfect storm that could push the already fragile American economy back into recession. Fed Chair Ben Bernanke dubbed it a "fiscal cliff." The media calls it Taxmageddon.

Topping the list is the upcoming expiration of the Bush tax cuts and of the 2009 stimulus tax cuts. Sitting on a huge budget surplus that he feared Congress would use to increase government spending, President George W. Bush followed through on his campaign promise to cut individual tax rates in 2001. To provide economic stimulus, more tax cuts were enacted in 2003. The most notable of these were the reduction in the capital gains and dividend rates to 15 percent.

In the wake of the financial crisis, President Obama and a Democratic Congress enacted an economic stimulus bill that included an expansion of the earned income tax credit, an increase in the child credit from $500 to $1,000 per child, and an extension of the American opportunity tax credit.

In December 2010, during a lame-duck session, Congress and the president agreed to extend most of the tax cuts until the end of 2012. Allowing all these tax cuts to expire on schedule would raise taxes by $152.7 billion in 2013.

Next on the list is the pending expiration of the alternative minimum tax patch. The exemption amounts and tax brackets of the individual alternative minimum tax are not indexed for inflation. That feature has converted the tax originally intended to raise revenue from a few wealthy families into a potential major new tax burden on middle-income taxpayers. Congress has passed a series of temporary adjustments to the tax over the last decade. But it has never reformed the AMT because of an unwillingness to identify offsetting tax increases or spending cuts to pay for permanent change.

The last temporary adjustment expired at the end of 2011. Assuming the Bush tax cuts are extended, the total tax increase resulting from the absence of AMT relief would be $124.7 billion in 2013.

December 2012 will also mark the expiration of the payroll tax holiday. The tax cut extension agreed to by Obama and Congress at the end of 2010 included a temporary rate reduction from 6.2 percent to 4.2 percent of the employee portion of the Social Security tax. Failure to extend the payroll tax holiday would raise taxes by an estimated $117.9 billion in 2013.

Temporary tax breaks are next on the list. The list of expiring provisions has grown from a mere handful a few decades ago to more than 60 that either have expired at the end of 2011 or will expire in 2012. These provisions include the research credit, the active financing exception from anti-deferral rules for multinationals, and the deduction for state and local sales taxes. Allowing all extenders to expire at the end of 2012 would raise taxes by $32.1 billion in 2013.

Next up are scheduled tax increases under the Patient Protection and Affordable Care Act. The biggest tax increase in the health care law is a new 3.8 percent tax on investment income of individuals earning more than $200,000 and couples earning more than $250,000. The total estimated tax increase from provisions in the health care law is $24.6 billion in 2013 and $262.9 billion over the 2013-2022 period.

Automatic spending cuts are another impending fiscal event. With the threat of reaching the statutory debt limit just a day away, Obama signed into law the Budget Control Act of 2011 on August 2, 2011.

The legislation provided that if Congress did not enact legislation that reduced the deficit by an additional $1.2 trillion over 10 years, automatic spending cuts would take place beginning in 2012. Congress failed to act. And so beginning in 2012, both defense and non-defense spending will be cut by $55 billion.

The February 2012 legislation that extended the payroll tax holiday also extended unemployment insurance for the long-term unemployed through December 31. The cost of the one-year extension was $30 billion.

As with AMT relief for individual taxpayers, Congress has repeatedly enacted temporary relief from a scheduled reduction in Medicare reimbursements paid to physicians. The last action on this issue was in February when Congress extended the fix and prevented a 27 percent pay cut for Medicare doctors. That relief cost $20 billion. It expires December 31.

Last but not least on the list is the debt limit. The current statutory debt ceiling on U.S. government debt is $16.394 trillion. Current projections estimate that the debt limit will be reached sometime shortly after the new year. During last summer's intense budget negotiations, Republicans used the threat of not approving an increase in the debt limit to force Democrats to agree to cuts in government spending. In August, immediately following the passage of that law, Standard and Poor's downgraded U.S. government debt from AAA to AA+.

Despite the stultifying economic effects of these impending events, the prospect of action anytime soon is unlikely. Congress and President Obama are gridlocked, and the coming election will only heighten tensions.

After the election, with leadership in flux and future committee assignments unsettled, the most likely outcome is that the outgoing Congress will duck any major decision-making by passing a short-term extension (perhaps for three or six months) so that no major changes in law will be triggered on December 31.

The reality is the economy could suffer considerable ill effects in anticipation of these changes. If there is even a minute possibility of Armageddon-like events, it will have a detrimental effect on financial markets, business investment planning, and consumer confidence. Let's hope the President and Congress act to avoid this so-called taxmaggeddon and finally realize the importance of a saner, simpler tax code.

Martin Sullivan is chief economist for Tax Analysts, writes extensively for its daily and weekly publications, and blogs regularly for Tax.com. An expert on corporate taxation, he is frequently cited in national media and has testified before Congress on issues related to tax reform. He is also author of "Corporate Tax Reform: Taxing Profits in the 21st Century."