Fiscal standoff puts payrolls, taxes in doubt
WASHINGTON -- If the nation goes over the "fiscal cliff," some Americans will wake up Tuesday with financial headaches to rival a New Year's Eve hangover.
More than 2 million long-term jobless would receive their final unemployment benefit check within days. Millions of taxpayers would be unable to file their returns early, resulting in delayed refunds. Taxes would rise immediately on workers across the board. And although some of those increases eventually might be reversed, the first paychecks of the year would be smaller until any legislative fixes kick in.
Even if the crisis is resolved quickly after the new year begins, as pressure mounts on President Obama and lawmakers, it poses a short-term administrative nightmare for businesses. And it would be a financial blow to millions of people struggling to make ends meet in the aftermath of the latest recession.
"As a working-class person, I would miss any money taken out of my paycheck," said Stephanie Smith, an office administrator in Sacramento, Calif. "I just feel that we're already paying high taxes, and it feels like we're still in a recession. Everybody wants to take money out of our paychecks, but nobody wants to put more in."
As the White House and Congress try to avoid the large tax increases and federal spending cuts coming next week, taxpayers, businesses, and even the Internal Revenue Service, are scrambling to figure out the effects if an agreement is not reached.
The fiscal pain could be averted by a last-minute deal. And even if there is none by Tuesday, Washington policymakers could retroactively reduce tax rates if they ultimately make a deal. But the uncertainty and short-term loss of income could damage an already fragile economy.
• Income taxes: Rates would rise on everyone as the George W. Bush-era tax cuts expire. Middle-income households would get hit hard, paying about $1,500 more a year in taxes.
• Payroll taxes: Rates would increase by 2 percentage points with the lapse of a temporary, two-year tax cut designed to boost the economy. Workers making $50,000 annually would take home about $40 less every two weeks.
• Long-term unemployment benefits: Checks would abruptly end for people receiving extra federal aid. State benefits would still be available, but workers would be out of luck once those ran out.
• Alternative minimum tax: The number of people facing the provision would skyrocket to about 33 million next year, from 4 million this year. The tax, enacted in 1969, was designed to make sure the very wealthy pay some income tax. But it was not indexed to inflation and needs to be fixed each year to avoid ensnaring middle-income households.
Although Congress at some point is expected to spare most of those people from that tax, delays in doing so mean that as many as 100 million people might not be able to file their returns until the end of March or later, according to the IRS. Delays would come as the IRS has to reprogram its system, as well as for taxpayers who would have to do special calculations to determine whether they owe money because of the tax.
Businesses already are struggling to adjust. They've got to figure out how much in federal taxes to withhold from employee paychecks starting next week. As of Thursday, though, the IRS still had not told employers what the 2013 withholding levels would be.
That limbo is particularly vexing for small firms, such as Golden State Magnetic & Penetrant. The Los Angeles company inspects, cleans and paints aircraft and aerospace components. The firm's president, Joanne Weinoe, does the payroll for herself and her 12 employees. At present, she doesn't know what the withholding should be for the next set of checks she cuts.
"I'm going to tear my hair out of my head and shoot myself," Weinoe joked, adding that she'll wait until the morning of Jan. 4, her next payday, before she makes any changes.
"If I have to adjust them, it'll be additional work for me," she said. "Every time they change something, it becomes more work for employers."
The IRS said it continues "to closely monitor the situation" and would "issue guidance by the end of the year."
Workers might not see the new income tax rates immediately reflected in their paychecks. The American Payroll Association is advising its members to continue to use 2012 withholding tables until they hear differently from the IRS.
The payroll service Payality Inc., with headquarters in Fresno County, Calif., is urging its 700 clients with 25,000 employees throughout the state to hold off on issuing paychecks and making direct deposits for January as long as they can in hopes that lawmakers and the Obama administration will strike a deal.
"We should have some direction by Dec. 31," company President Chet Reilly said. "Then we'll have to scramble as fast as we can."
In the meantime, Payality has programmed its software to assume the fiscal impasse won't be resolved and that the payroll tax will revert to 6.2 percent for employees from the 4.2 percent level of the last two years, he said.
"We think the likelihood of going off the 'fiscal cliff' is fairly large," he said. "We have it set that way and then we can dial it back" if an agreement is reached.
Adding to the uncertainty is the ability of Treasury Secretary Timothy F. Geithner, who oversees the IRS, to maintain the 2012 withholding levels even after tax rates rise.
Geithner could use the authority to prevent a short-term hit to the economy and potential confusion to employers if it appears a deal to prevent some of the tax rate increases was still possible even after the New Year's Eve deadline. There's precedent for such a move. In 1992, President George H.W. Bush ordered withholding levels temporarily set lower than federal tax rates to stimulate the economy.
Geithner has been cagey about whether he would take such a step.
"Don't over-interpret what that authority gives me," he told Bloomberg TV last month. "It does not give me the authority to . let (Congress) avoid making some decisions on rates and policy."
A Treasury spokesman had no further comment Thursday.
Freezing withholding levels would help for a short time, because it would prevent the loss to consumers of about $10 billion every two-week pay period in higher taxes, said Mark Zandi, chief economist at Moody's Analytics. But it is not a long-term solution to the hit the economy would take from a continued standoff.
Failure to prevent the tax increases and spending cuts, he said, would lead to drops in financial markets and remove incentive for businesses to invest. Most economists predict it would send the U.S. into another recession in the first half of next year.
"It's not the end of the world if we go into 2013 without a deal. In fact at this point I expect that," Zandi said. "If they freeze the withholding, I think they'd probably have until mid-January until [the budget impasse] starts doing some real damage."
But the damage would begin almost immediately for more than 2 million long-term unemployed Americans, according to the National Employment Law Project. A benefits extension has been caught up in the negotiations, meaning money is authorized only through the week ending Saturday. The labor market has been improving slowly. But unemployment, which was 7.7 percent in November, has remained stubbornly high.
"The check that's issued this week will be their final check," said Christine Owens, the group's executive director.