Fiscal Cliff Averted For Now, But City Programs Still Face Cuts

The House acted in the 13th hour to reinstate the Bush-era tax cuts, but left many major fiscal issues—including those that could hurt cities—unresolved.
(Published Jan 7, 2013)

Congress and President Obama’s last-minute legislation averting the fiscal cliff prevented income tax increases on nearly all Americans from going into effect, but there is still much more work to be done.

Programs benefitting cities, such as Community Block Development Grants, are still at risk of funding cuts, and the proposal to eliminate or scale back the income tax exemption for municipal bond interest could re-emerge in future congressional negotiations. In addition, the U.S. Treasury Department has already suspended the issuance of State and Local Government Series (SLGS) treasury securities.

It was widely assumed that if Congress failed to act, it would send the nation’s economy into a second recession. The final legislation, however, was far from the grand bargain envisioned in 2011 when the fiscal cliff was put in place to force action. While the deal preserved the Bush-era tax cuts for most earners and made other changes to the tax code, the budget cuts necessary to avert sequestration were not made, and the debt ceiling was not increased, setting up another series of “cliffs” in the coming months.

Highlights of what was included in the bill:

  • The Bush-era tax cuts were extended for individuals earning up to $400,000 and couples earning up to $450,000. The tax rate for income above those thresholds increased from 35 percent to 39.6 percent.
  • Personal exemptions will phase out for higher earners, and itemized deductions will be significantly limited for individuals earning more than $250,000 and couples earning over $300,000.
  • The alternative minimum tax (AMT) was permanently “fixed” to ensure that the AMT does not *Unemployment benefits were extended for an additional year.
  • Sequestration was delayed for two months.

What was not included in the bill:

  • The payroll tax holiday was not extended, so employee payroll taxes funding Social Security will increase from 4.2 percent to 6.2 percent, effective Jan. 1.
  • The debt ceiling, which was reached just before the end of 2012, was not increased.
  • Although sequestration was delayed, there was no agreement on spending cuts or entitlement reform.

The tax increases may have a negative impact on the national economy, although the scope of the impact is unclear. The phase-out of the personal exemptions and limitations on itemized deductions may result in less tax revenue for the state of Minnesota.

Debt Ceiling
In addition, Congress will have to act to raise the debt ceiling, or the government will default on its debt obligations. Although the debt ceiling was reached just before the end of 2012, the U.S. Treasury Department has taken “extraordinary measures” to free up space for approximately two months’ worth of additional borrowing.

The extraordinary measures include suspending the issuance of SLGS treasury securities. The Treasury Department issues SLGS to state and local governments, at the request of the unit of government, to assist in complying with federal tax laws when they have cash proceeds to invest from their issuance of tax-exempt bonds. Nationwide, approximately $4 billion to $17 billion in SLGS are issued per month.

Now that SLGS sales are suspended, some state and local governments issuing certain types of new debt will have to invest the proceeds in alternative assets to comply with tax law. This could add cost and inconvenience.

Disagreement over raising the debt ceiling in 2011 was the impetus for the Budget Control Act of 2011 and the looming threat of sequestration. There is no indication that debate of either measure will be less contentious, creating the prospect of months of uncertainty for the economy and cities.

Sequestration
Congress and the president will once again gear up for debate on spending cuts in order to avert the across-the-board spending cuts, known as sequestration, which are now scheduled to take effect on March 1, 2013. Previous Cities Bulletin articles have discussed the potential impacts that sequestration would have on cities, including cuts to Community Block Development Grants and environmental programs like the Clean Water State Revolving Fund. All of these potential cuts are still looming.

The only ways to avoid sequestration is for Congress to enact budget cuts or raise additional revenue, so a compromise could still negatively impact programs relied upon by cities. The League will continue to analyze the potential impacts of sequestration and any future budget deals on Minnesota cities.

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