‘Fiscal Cliff’ Could Mean $22 Billion More in Taxes

By Eric Boehm | PA Independent

HARRISBURG — Pennsylvanians will face billions of dollars in higher taxes unless Congress acts by the end of the year to defuse a threatening combination of tax increases and spending cuts contained in the so-called “fiscal cliff.”

A recent report by the state’s Independent Fiscal Office, Pennsylvania’s version of the federal Congressional Budget Office, suggests the fiscal cliff would drain billions from Pennsylvania’s economy, putting a strain on state tax revenues and the state budget. Based on estimates from the Tax Policy Center, a nonpartisan think tank in Washington, D.C., the IFO projects the fiscal cliff will raise federal taxes by $536 billion — with about 4.1 percent of that total, or $22 billion, coming from the pockets of Pennsylvania taxpayers.

Nationally, analysts believe the fiscal cliff will substantially reduce economic growth and may tip the nation into another recession in 2013.

Matthew Knittel, director of the IFO, said he expects the consequences of the fiscal cliff in Pennsylvania to mirror whatever happens nationally.

“If none of these (tax cuts) got extended, it would have a significant drag on economic growth, and there is no reason to think the effect in Pennsylvania would be any different,” he said.

Knittel said the $22 billion tax hike is the “worst-case scenario,” because most experts believe a “mixed bag” of tax cuts and spending would be extended into 2013.

The fiscal cliff is a combination of the expiration of the Bush-era tax cuts and a cost-cutting maneuver known as sequestration, enacted by Congress during the tense battle over raising the debt limit in 2011.

The expiration of the tax cuts would mean higher income taxes for all Americans, along with higher taxes on capital gains, larger payments for Social Security and a 50 percent reduction in the child tax credit.

On the spending side, sequestration would cause about $110 billion in cuts at the federal level, resulting in the loss of about $60 million in federal grants for Pennsylvania. It would not affect federal funding for Medicaid or transportation, but it could hit grants that fund defense, education and other subsidies to states.

The question facing Congress is: What stays, and what goes?

Whatever outcome congressional leaders agree to will have significant effects on state governments, said Anne Stauffer, a project director for the Pew Center on the States, a national nonprofit think tank based in Washington, D.C.

“The fiscal cliff is not just a federal issue,” Stauffer said. “The implications for states should be part of the discussion so that problems are not simply shifted from one level of government to another.”

Many states use the federal deductions to determine taxable income at the state level, meaning the end of some federal deductions could cause higher income taxes at the state level, as well.

Fortunately for Pennsylvania, the state uses a flat income tax with few deductions not linked to the federal tax system, so taxpayers in the Keystone State will not be hit with that same double-whammy of higher taxes, though it would still have to deal with the loss of 7 percent of federal grants, about in line with the national average.

Even if Pennsylvania dodges part of the tax bullet, higher federal taxes on payroll and income means less cash in consumers’ wallets — and that translates into lower sales tax collections at the state level.

Knittel said it is likely the payroll tax cut won’t be extended. If so, Pennsylvanians’ paychecks will be a total of $5 billion lighter next year, after the rate jumps from 4.2 percent to 6.2 percent.

The payroll tax increase means the average household in Pennsylvania with an income of $50,000 would face $1,000 in additional taxes, even before higher income taxes or other costs are figured.

Since most residents would use those extra dollars to purchase goods and services, the trickle-down effect is that state sales tax coffers will miss out on about $80 million of future revenues, Knittel estimated.

He also expects income tax rates to climb for high earners — President Obama wants to extend the cuts for taxpayers making less than $250,000 per year, but allow them to expire for people above that threshold.

But as bad as the tax hikes could be, Knittel and Shaeffer agree the uncertainty created by the fiscal cliff scenario is worse.

Business leaders say the unknowns in the tax code are stalling the tentative recovery.

“It has forced employers to stand in place,” said Kevin Shivers, executive director of the Pennsylvania chapter of the National Federation of Independent Businesses, which represents small business owners. “It is preventing them from hiring, it is preventing them from expanding.

State policymakers are also stuck in neutral, unable to plan for 2013 because they don’t know what parts — if any — of the tax increases and spending cuts will become reality.

Speaking to reporters Monday, Gov. Tom Corbett said the pending tax changes from the fiscal cliff were putting a strain on budgetary plans in Pennsylvania and in other states. He called the tax increases caused by going over the cliff “overwhelming.”

“The fiscal cliff is frightening,” Corbett said Monday. “I fear for the economy.  I fear for another recession.”

It’s all up to Congress now, but federal policymakers are also stuck between the proverbial rock and hard place.

The CBO estimates allowing the nation to go over the cliff would cause GDP growth to drop from 2.2 percent to 0.5 percent during 2013, throwing the nation back into a recession and sending unemployment back above 9 percent.

But avoiding the cliff has its problems, too.

A separate CBO study concludes that dodging the fiscal cliff would keep the economy out of recession in 2013, “but adopting this policy without imposing comparable restraint in future years would have substantial economic costs in the long run.”

Stauffer summed up the mess facing states, businesses and taxpayers.

“Right now there is just not a lot of certainty about what will happen with the fiscal cliff,” she said.

Contact Eric Boehm at Eric@PAIndependent.com and follow @PAIndependent on Twitter for more.

— Edited by John Trump JTrump@watchdog.org