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The short message that should be taken away from the so-called “fiscal cliff” legislation passed last night is that it is no time to relax.

The House of Representatives finally voted on legislation to avert the much-feared and much less understood “fiscal cliff” Late Tuesday night. The best of the deal takes us back to policies drawn from the presidency of Bill Clinton. The worst of the deal stems from policies that simply reflect a failure of the 112th Congress to govern—a failure to deal with present-day economic realities facing Americans emerging, haltingly, from the worst recession since the Great Depression.

It isn’t a matter of compromise. It is a matter of governing. Americans have had to wait until almost the witching hour before knowing what their tax bill would look like in 2013. If they can figure it out based on the 157-page bill that passed the Senate before being presented to the House of Representatives, which contained provisions of limited duration and obscure calculations, good luck. By our analysis, the President gave in on a ton of issues, maybe the Republicans did too, though they’re harder to find, and some of the day-of-reckoning of major issues has been delayed. Here is our scorecard on the fiscal cliff mini-bargain:

Charitable Deductions and Marginal Tax Rates

We’ve already seen the headlines that the fiscal cliff bill could hurt charitable giving. How? Did the President get his proposal of a 28 percent tax rate limit on itemized deductions? No. Remember, that was the touchstone for the opposition of charities to the President’s budget proposals throughout his administration and now in the fiscal cliff proposal. The President gave the signal for Vice President Biden and Senate Minority Leader McConnell to drop that idea.

Remember the notion that the Republicans might set a cap on the total amount of permitted deductions? That’s not in the cliff deal either.

H.R. 8 reinstates an obscure and little understood Clinton era provision called the “Pease Amendment.” Its impact on charitable giving—and other itemized deductions—is truly minor, much less than the President’s 28 percent limit or the Romney deduction cap. The Pease Amendment, named after the legislator who originally proposed it two decades ago, reduces the value of deductions for wealthy households by all of 3 percent of a taxpayer’s income above a particular threshold. The Pease threshold for calculating the reduction in the value of deductions was changed to $300,000 for married taxpayers filing jointly, though half that for married couples filing separately, and $250,000 for unmarried individual taxpayers.

The calculation would, in bare bones terms, work like this: A taxpayer (married filing jointly) with an income of $500,000 would obviously be subject to the Pease Amendment “haircut” on itemized deductions. The $300,000 threshold or “applicable amount” is subtracted from the $500,000 income for a total of $200,000. Three percent of that number is $6,000, which is the amount that the value of the taxpayer’s itemized deductions would be reduced. There would be no change, however, in the tax rate for deductibility purposes, no 28 percent cap for example. The reduction in the value of deductions cannot exceed 80 percent of the total deductions (in other words, for that $500,000 taxpayer, the $6,000 Pease reduction would be 80 percent if the taxpayer’s total deductions were $7,500; let’s hope that a taxpayer with a gross income of a half million turns out to be a little more charitably generous than that, especially since the Pease calculation includes almost all itemized deductions).

Now, factor in the issue of tax rates that will rise in the fiscal cliff deal. The President backed down on raising the tax rates of all individual taxpayers above $200,000 and families above $250,000, agreeing to tax hikes only for individuals making $400,000 and families above $450,000 from 35 percent to 39.6 percent. The Pease amendment, according to the Tax Policy Center, operates really as a very minor tax surcharge on the very wealthy. If the original Clinton era Pease calculation applied, the marginal tax rate of top level taxpayers affected by the three percent Pease amendment calculation would have risen to 40.79 percent. Given the increase in the applicable amount threshold, the tax “surcharge” so to speak is even smaller.

No offense to our nonprofit sector colleagues, but reinstating the Clinton era Pease amendment and raising the marginal tax rates of only the top income bracket constitutes an absolutely minimal touch on charitable contributions.

Other Taxes for the Rest of Us

Did anyone notice how quickly both parties came to agree on allowing the payroll tax “holiday” to expire? For the past two years due to the recession, the payroll tax had been cut from 6.2 percent to 4.2 percent. With the end of 2012, the payroll tax that ostensibly goes to pay for Social Security goes back to 6.2 percent—but not for everyone. Remember that the payroll tax is an extraordinarily regressive tax, applicable to people earning $110,000 or less, but exempting those with higher incomes. The result is that the average worker who pays the payroll tax will pay $960 more in 2013, the worker earning $110,000 a year will pay $2,200 more.  

There’s no other way to call this: When President Obama, the Democrats, and the Republicans say that they have protected the middle class from tax increases, they are wrong or perhaps intentionally not telling the truth. Middle income workers and actually lower income workers will be taking a hit—two-thirds of the bottom 20 percent of Americans by income will be affected by the expiration of the payroll tax holiday.

The President and his Democratic colleagues gave in capital gains and dividend income as well. The President’s proposal was for the capital gains tax rate to increase from 15 to 20 percent and for dividend income to be taxed as ordinary income, essentially alleviating earners like Mitt Romney of one means by which they pay such low overall taxes. Under the cliff deal, the rate on both climbs only to 20 percent and only individuals earning more than $400,000 and families more than $450,000, that is, for taxpayers only in the top marginal income tax bracket. After the controversy over Romney’s taxes during the election and after the President’s advocacy of the so-called “Buffett tax,” the cap gains and dividend income agreement is a major step backwards for the President’s agenda.

The President also retreated somewhat on the estate tax in response to Republicans and farm-state Democrats such as Max Baucus (D-Mont.), Claire McCaskill (D-Mo.), and Jon Tester (D-Mont.). Under the President’s original plan, the estate tax would be 45 percent after exempting the first $3.5 million of inherited assets, compared to the Bush-era 35 percent after a $5 million exemption or, if no deal were struck, the pre-Bush level of 55 percent after exempting the first $1 million. The final agreement was a $5 million exemption (actually $5,120,000 in 2013 as adjusted for inflation) as the Republicans wanted and a tax rate increase only to 40 percent.

Is it any wonder that the final cliff bill raises not only less revenues than the President’s proposal, but even less than Speaker Boehner’s “Plan B”? The major culprits are the smaller than hoped forcapital gains and dividend tax rates, the increase in the threshold for marginal tax increases to $400,000/$450,000, the shift in the treatment of itemized deductions from the 28 percent tax rate limit to the Pease amendment, and the compromise on the estate tax.  

Saving Programs

The good news for nonprofits and the communities they serve is that a variety of programs that benefit working class and lower income people have been saved—for the time being:

  • Emergency unemployment benefits for people unemployed for 26 weeks or longer were extended for one year.
  • The stimulus expansions of the child tax credit, the Earned Income Tax Credit, and the American Opportunity Tax Credit were continued for five years.
  • The Production Tax Credit (an incentive for renewable energy) was also extended by one year as well as a number of other attractive tax incentives, including a tax credit for car race track owners and the extension of a rum excise tax benefiting producers in Puerto Rico and the U.S. Virgin Islands.
  • Senator Maria Cantwell (D-Wash.) issued a release about other important incentives extended in the bill, including the New Markets Tax Credit and the Low-Income Housing Tax Credit.
  • The cliff bill also extended the long-stymied farm bill avoiding a possible spike in milk prices that, according to Agriculture Secretary Tom Vilsack, would have risen at the supermarket from $3.60 a gallon to $7.00 had no action been taken.

The other major action not taken was the sequester, the list of budget cuts split between military expenditures and discretionary domestic spending that would have devastated many safety net programs. The White House and Congress agreed to put off budget cuts for all of two months, for reasons we suspect that have more to do with protecting the military than providing resources for continuing anti-poverty programs. Two months. That’s all. And a barely altered 113th Congress will have to deal with the spending issues that the 112th could not address.  

The Path to a Temporary Mini-Bargain on the Cliff

Two days before New Year’s, President Obama was “modestly optimistic” that a deal of some sort would be struck to avert the absolute worst of the fiscal cliff, and Republican Senator Lindsey Graham (R-S.C.) thought that the President had won a political victory, but sticking points continued to pop up until Vice President Biden took over negotiations using the old-time political bonhomie that he possesses in excess to fashion a deal that might pass both houses.

A grand bargain? More like a stopgap measure to buy time until the next do-or-die showdown over the budget deficit, tax reform, discretionary domestic spending, and entitlement reform. It is a “just enough” bargain to keep all of us on our toes in the next weeks and months to see what additional fiscal shoes will drop. Every element of the negotiations that go forward from this point on, not just the specific calculations on the charitable deduction, will be of prime importance to nonprofits.

Our impression is that the Democratic and Republican leadership teams had been close to an agreement a week or so before Christmas. At that time, the negotiations were really an Obama and Boehner show, and the difference in their positions in the grand scheme of things was relatively minimal, maybe $40-45 billion a year over 10 years, a blip measured against the size of the U.S. federal budget. But Boehner represents a party in disarray, dominated even in its decline by a coterie of Tea Party Republicans who couldn’t even support Boehner’s negotiating position, much less a deal with the White House.

For all intents and purposes, these members of Congress, some of whom will be filling out unemployment forms starting on Thursday because they were defeated on November 6, were willing to whack the middle class with tax increases and whack poor people with sequestration-mandated cuts to social safety net programs in order to protect millionaires and billionaires from a tax increase—which a majority of them in polls have said that they don’t oppose. As much as one might not care for Republicans as a brand, one has to feel sympathy for Speaker Boehner, who couldn’t get his own party to support anything, called for a vote to establish the principal of “a majority of the majority” supporting a budget package, and endured one of the most embarrassing debacles imaginable over the failure of his “Plan B” alternative. Hardly a grand bargain, but the “deal” was inches away, But the Speaker can’t cut a deal with anyone when he can’t speak for his own party or, in the words of Tampa Bay Times writer, Daniel Ruth, he “speaks, but no one listens.” This presupposes that the likes of Republican Representatives Tim Huelskamp (Kans.), David Schweikert (Ariz.), Justin Amash (Mich.), Allen West (Fla.), and Michele Bachmann (Minn.), among others, are capable of listening to anyone.

Rich people don’t have much to fear in the cliff deal.   Compare it to the situation in France, where Socialist President Francois Hollande won election by campaigning for a 75 percent tax rate on the incomes of the wealthy, opposed by affluent citizens such as actor Gerard Depardieu who threatened to move to Belgium, and overturned by the French high court because the rate was placed on individual incomes when French law taxes based on household incomes. And Republicans think that Obama’s 39.6 percent tax rate is socialist? Despite the silliness of petitions for states to secede from the union, we suspect that few rich Americans will be looking to move to Belgium to live as tax exiles.

Perhaps we never fully grasped the big picture, as some top leaders of the left and right suggested that the wisest course would be for the nation to plunge over the cliff. Right wing pundits suggested that the pain that would result for middle-income taxpayers would force them to recognize the need to cut spending for domestic programs and entitlements. On the left, the thought was that this might mobilize people into action on tax rates for the wealthy and perhaps a less hysterical perspective on the impact of the national deficit. The past year of political dithering until the November 6 election felt to us disastrous, with little pieces of the pie harming ordinary Americans, confirmed and underscored by a cliff bill that doesn’t do much to raise significant revenues or reduce the nation’s ever-expanding concentration of wealth.

We’ve seen lots of pronouncements, including from philanthropists, about how going over the cliff would undermine our common national purpose. Tell that to the millions of poor people and the additional millions of unemployed who might have used their wildest imaginations to perceive how their plights reflect some illusory national purpose. Rather, what was at stake was the nation’s ability to govern. Alice Rivlin of the Brookings Institution decried the notion that the nation would be best served by plummeting over the cliff. “Getting past the ‘cliff’,” Rivlin wrote, “is just the first indication of whether we have elected a set of leaders capable of solving problems.”

Rivlin’s thought should ring loud for nonprofits. The fiscal cliff isn’t just a matter of “saving” the maximum deductibility of charitable donations or avoiding the reinstatement of the arcane and minimal Pease amendment, but recognizing how dysfunctional the nation has become and how the communities nonprofits serve are the primary victims. If the focus of nonprofit advocates leaving shoe leather in the halls of the Capitol is simply on maximizing the value of the charitable deduction or, perhaps more accurately, maximizing the value of the deduction for ultra-wealthy tax itemizers, then the result, reflected in the fiscal cliff legislation and future bills to be addressed in the next couple of months, will be a truly pyrrhic victory for the communities nonprofits serve.

 

Correction: The analysis of the Pease amendment calculation on itemized deductions we first reported was incorrect because of a change in the fiscal cliff bill that we missed. The “applicable amount” to be subtracted from a taxpayer’s income to determine how much one’s itemized deductions would be reduced is actually $300,000 for taxpayers who are married filing jointly and $250,000 for single taxpayers, not $177,550. NPQ regrets the error.