Political capital and control
While President Obama won the electoral college by a significant margin, his likely narrow victory in the popular vote may limit his political capital. His party retains control of the Senate, but it didn’t reach the 60 members necessary to become filibuster-proof (even when considering independents who likely will caucus with the Democrats). So the Democrats’ simple majority won’t be enough to pass legislation in the Senate. In the House, Republicans retain control by a margin similar to their current one.
So Washington will essentially remain as divided in 2013 — at least in terms of party affiliation — as it is now. Compromise will be necessary to get any legislation passed and signed into law.
The tax impact
Most 2012 income tax rates are scheduled to increase in 2013, and many tax breaks are set to expire. In addition, several valuable tax breaks that expired at the end of 2011 have yet to be extended. Without congressional action, most taxpayers will face higher tax bills next year.
Yet, as spelled out in the presidential campaign, as well as many Senate and House races, Democrats and Republicans have different views on how these expiring rates and breaks should be addressed.
For example, the president has proposed retaining 2012 rates for only the middle and lower brackets — taxable income below $200,000 (singles), $225,000 (heads of households) or $250,000 (married filing jointly; $125,000 for separate filers). Republicans generally want to extend 2012 rates for all taxpayers and eventually reduce rates as part of overall tax reform.
Further complicating matters are the automatic spending cuts scheduled to go into effect in 2013 under the Budget Control Act of 2011, which was passed in order to raise the debt ceiling. The cuts would dramatically reduce spending on both defense and domestic programs and thus are undesirable to both parties.
To address the fiscal cliff (the combination of the expiring tax rates and breaks and the scheduled spending cuts), the president is going to have to work closely with both his own party and the Republicans, and both sides will likely need to be willing to make some compromises.
Given the level of discord in Washington during the last four years and the lack of significant change in Washington’s makeup for 2013, achieving the compromise needed to address the fiscal cliff will likely be a challenge. But the enormity of the potential impact of what will happen without new legislation being signed into law provides an incentive for Congress and the president to find a solution.
What is the potential timing of legislation? The lame-duck Congress is expected to return briefly next week, but then will break for Thanksgiving. It’s possible that some tax legislation could be passed in December, which would be beneficial because it would allow enough time to implement appropriate year-end tax planning strategies. But given the time it could take to reach a compromise, it may be more likely that no tax legislation will be signed into law until next year, likely retroactively extending at least some 2012 rates and breaks.
The best thing you can do
With today’s tax law uncertainty, the best thing you can do now is to be prepared for various scenarios so you can quickly implement year-end tax planning strategies once tax legislation is passed — or it becomes clear that tax law changes won’t be passed this year.