What Happens If We Go Over the Cliff?

Dec. 31, 2012 -- America is swiftly approaching the fiscal cliff.

President Obama and congressional leaders have talked for weeks with varying degrees of frequency and success at compromising, and one precept resonates throughout the public statements of politicians and economists: the so-called "fiscal cliff" would be a very bad thing.

But what actually happens if Washington takes us over it?

As has been well documented, the "cliff" is not one thing, but a ball of expiring economic provisions that lead to automatic policy changes at year's end, loosely grouped under the catch phrase. They fall into two categories, taxes and spending.

Should we fall off the cliff, the tax code would change most dramatically with the expiration of the so-called "Bush tax cuts," which created new brackets and lowered tax rates for both middle-class and high earners. According to the Tax Policy Center at the Washington, D.C.-based Brookings Institution, the average American taxpayer would see a tax hike of $3,446, ABC's David Muir reported for "World News."

Where do the hikes fall, exactly? For many tax brackets, rates would jump by at least three percentage points. The middle class would see the worst of it, according to analysis from the Congressional Research Service, the nonpartisan research arm that studies policy changes at Congress's request.

For high earners, married couples making more than $222,300 but less than $397,000, rates would jump from 33 percent to 36 percent. For the highest earners, couples making over $397,000, taxes would rise from 35 percent to 39.6 percent.

But they'd rise for almost everyone else, too. Couples making $145,900 - $222,300 would see a rate jump from 28 percent to 31 percent. Couples making $72,300 - $145,900 would see rates jump from 25 percent to 28 percent.

The middle class would take the biggest hit: Married couples earning $60,350 - $72,300 would see tax rates jump from 15 percent to 28 percent. That means that without any credits or deductions, a couple making $65,000 would go from taking home $55,250 to taking home $46,800 next year if Congress and the president fail to strike a deal.

The cliff's tax implications go beyond the simple income-tax rate: The Alternative Minimum Tax (AMT) and the estate tax are also on the table with year-end deadlines.

The AMT is a tax that prevents high earners from escaping income-tax liability by claiming too many deductions. Taxpayers over a certain income add back certain deductions to see if they must pay a minimum rate. Ever since Bush's tax cuts, Congress has repeatedly extended an "AMT patch" to maintain the income threshold. According to the Congressional Research Service, if Congress doesn't act again this year, that threshold will drop from $74,450 to $45,000 for married couples and from $48,450 to $33,750 for individuals, exposing more people to the alternative minimum.

The estate tax, demonized by Republicans as the dreaded "death tax," would change significantly. Right now, estates of over $5.12 million are taxed at a maximum of 35 percent. If Congress doesn't act, next year estates of over $1 million will be taxed at 55 percent.

No one likes paying taxes, but the spending side of the cliff isn't supposed to be all that fun, either.

The "cliff" was born from the idea that Congress could impose a deadline on itself, hanging an unpleasant combination of spending cuts over its own head. In 2011, when President Obama and congressional leaders wrangled over a proposed increase to the debt limit, a maneuver Congress had typically done without any fuss, they couldn't agree on a deficit-reduction package that would satisfy GOP demands for fiscal restraint. So they created the now-infamous deficit-reduction "supercommittee," asked it to recommend a plan, and gave it an ultimatum: If you fail, automatic spending cuts will be triggered, half from defense, and half from discretionary domestic programs, mostly shielding mandatory entitlements, such as Social Security.

The committee failed, and Congress gave itself until 2013 to solve the problem, extending its own deadline before the set of "budget sequestration" spending caps would take effect.

Those cuts would save about $1.1 trillion over 10 years, the Congressional Budget Office estimated after Congress passed the law, the Budget Control Act, which created the cliff's spending ultimatum.

In 2013, that means defense programs would see a cut of $54 billion, according to the Center for Budget and Policy Priorities (CBPP)--but the Budget Control Act specifies that spending on the wars in Afghanistan and Iraq would be protected from any automatic cuts.

Entitlements wouldn't see the worst of it--but they wouldn't be exempt, either.

Outside of defense spending, $38.6 billion would be shaved, proportionally, from discretionary domestic spending programs other than veterans' medical care and Pell grants, according to CBPP. But Medicare would take a hit, with cuts to provider payments (theoretically protecting benefits) limited to 2 percent in any year. CBPP estimates $10.8 billion would be cut from Medicare providers in 2013. Another $5.2 billion in cuts would come from other mandatory programs, the largest being farm subsidies.

A handful of popular domestic programs would be exempt from any cuts, at all: Social Security, Medicaid, the Children's Health Insurance Program (CHIP), and food stamps.

The fallout of all this, analysts say, would be a swift economic downturn.

Thanks mostly to the tax increases, many have predicted an immediate economic slowdown. In August, the Congressional Budget Office forecasted that the cliff would bring the U.S. down to negative .5 percent economic growth for 2013. By the fourth quarter of next year, CBO predicted, unemployment would rise to 9.1 percent.

"The economy would shrink by about 3.9 percent in the just the first quarter alone," said Jason Peuquet, research director at the Center for a Responsible Federal Budget. "You can be pretty sure that after at least a couple weeks we'd be feeling those effects."

While the cuts would happen over 10 years, and while the tax hikes might not depress income so drastically over just a few weeks, Peuquet said the cliff would damage confidence in the country's ability to pay its debts over the long term.

On the one hand, going over the cliff might not really mean going over it. The Budget Control Act mandated spending caps over 10 years, but Congress writes the laws and makes the rules. After the president and lawmakers wriggled out of their self-imposed ultimatum to pass a deficit-reduction package in 2011, punting the deadline to today, it's conceivable that Washington will re-write its own rules again.

Taxes have been adjusted retroactively in the past, and it's not as if Congress can't pass a new tax law tomorrow that would reapply the 2012 rates. Liberals have proposed that we should go over the cliff, to force Republicans to argue against a tax cut for the middle class. Underpinning their argument is a sense that the cliff is at worst a facade, and at least malleable.

None of the cliff's upshots sound too good. On the other hand, if Washington wants to save money regardless of how it could affect the economy, allowing tax hikes and across-the-board cuts is one simple way to do it.