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MN2020 - Fiscal Cliff’s Impact on Minnesotans
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Fiscal Cliff’s Impact on Minnesotans

December 06, 2012 By Alex Christensen, Policy Associate

Front and center in the fiscal cliff debate is how to handle the expiring Bush tax cuts, but they're just one issue in a complex mix of harmful policies scheduled to begin at the start of 2013.

According to Minnesota's latest budget forecast, if the U.S. goes over the fiscal cliff, the state unemployment rate—currently 5.8 percent—could rise above 7 percent by the end of 2014. That's roughly 70,000 fewer jobs than currently forecasted.

At the same time, middle-class tax hikes will hit the 95% of Minnesota households still being squeezed by the last recession. That creates an unwelcome combination for Minnesota: families with less money to spend and an economy that does not need another obstacle to recovery.

Two sets of taxes in the fiscal cliff will impact Minnesotans' purchasing power: payroll and income. Since the end of 2010, the U.S. has been on a Payroll Tax Holiday. The Social Security tax dropped from 6.2% to 4.2%, with the intent of pumping a bit more money to American families during a frustratingly-long recession. That holiday is scheduled to end when the U.S. hits the fiscal cliff. Middle class families are going to immediately and disproportionately feel the impact. Not only are average wages stagnated, but each paycheck will be at least 2% smaller (excluding income tax hikes). Also remember income above $110,000 per year is not subject to the social security tax, making this a regressive tax.

For the median Minnesota household, the end of the payroll tax holiday alone will cost over $1,000 in 2013. That amounts to $140 billion across the U.S. that will not be going towards buying groceries or other consumer goods. When the economy is finally regaining footing, leveling a blow like this is not a recipe for continued growth.

The other major taxes in the Fiscal Cliff are the Bush tax cuts, which took effect for 10 years in 2001 before being extended one more year at the end of 2011. Letting them expire will have a significant impact on households of all incomes, but especially for the middle class. For the median family, the effects of the tax increase will be the same as those of the payroll tax holiday: less income at a time when a full-blown recovery is just beginning.

 [ chart: click article title to view in browser ]
Source: New York Times

The overall effective tax rate of the median Minnesota family will jump about 3% to around 31% as a result of the fiscal cliff. If all the tax hikes go into effect, a wealthier family will also see a similar jump in overall effective tax rates to about 34%.

Top earners are better situated to pay slightly more in taxes. On top of that, the impact on those top earners might be less than you would expect. If all the tax cuts are extended except for the top tax bracket, high-earning families would still pay lower taxes on their first $200,000 of income. A Minnesota household making $250,000 a year would pay about $275, or about 0.1%, more a year under this plan.

However, if conservatives hold middle-class tax cuts hostage in an effort to protect top earners and we go over the fiscal cliff, median income households will take home $1,703 less annually, with 59% of the increase coming from the payroll tax and the other 41% from the income tax rates. Those earning above $250,000 in Minnesota would see a roughly $6,000 tax hike if all tax cuts expire.

[ chart: click article title to view in browser ]
Sources: US Census, New York Times, Tax Foundation, ForbesKaiser Family Foundation, MN Department of Revenue, Federal Reserve Economic Data, Bankrate.com

On the current fiscal cliff trajectory, the average Minnesota household would be left with $26,681 of income—after taking into account some basic and nearly universal costs, like health insurance; a mortgage; state and local taxes; and car payments. That may not sound difficult to live on, but that money will have to stretch to pay for all the other costs a family incurs—although different families pay very different amounts for each. A family’s gas, food, and clothing spending comes from that number. So does college savings, food and holiday gifts, and household utility bills.

The $1,703 will go a long way in helping the average Minnesota family pay for its long list of expenses. It might sound like a broken record at this point, but the economy continues to struggle and wages have been stagnant for many Minnesotans. Middle class families need that money to get through the end of this tough economic period.

Extending these temporary middle class tax cuts will have the added benefit of helping grow the economy as a whole. Middle class families will not hoard that extra $1,703, they will put it back into the economy. That means an increase in sales for businesses, which will give those businesses the added demand to justify hiring at a faster rate. Since most of the US economy is based on consumer spending, extending the cuts for the lower- and middle-class will bolster economic growth.

Right now, policy needs to focus on raising household wages and creating jobs. Cutting the deficit needs to be addressed, but it shouldn't come at the cost of current growth. The Bush tax cuts, which were always supposed to be temporary, will have to end. They should end long enough from now that the increases won’t pinch the average household or the recovery, but not too long that they keep adding to the deficit unnecessarily.

Whenever it the time is, it probably will not be easy politically. Senator-elect Angus King, Independent from Maine, has a novel idea: end the rest of the Bush tax cuts automatically when certain economic indicators get to an acceptable level—like unemployment below 5% or when annual GDP growth reaches 5%.

For now, extending the payroll tax holiday and Bush tax cuts for the middle-class will avoid putting the squeeze on average Minnesotans while the economy gains its footing and high unemployment can drop. This path would keep about $1,700 in the median family’s pockets for the near future, and that is a smart plan for staying on the road to recovery.

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