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Overview | What is the fiscal cliff? What will happen if we “go over” it? In this lesson, students explore some basic quantitative consequences of falling off the fiscal cliff by looking at the effects that changing income tax rates and payroll tax rates will have for individual taxpayers and the federal government.



Materials | Computers with Internet access, chart paper and calculators

Warm-Up | Have students examine the New York Times interactive “Your Coming Tax Cut (or Not)” (also available as a printable PDF), which represents the impact of the “Bush tax cuts” of 2001 and 2003. Explain to students that these tax cuts lowered the rate at which individual income was taxed by the federal government and have students analyze and discuss the interactive, exploring questions like “How much does an average person save per year because of these cuts?” and “Who benefits most?”

Tell the students that these tax cuts were extended by President Obama but are scheduled to expire at the end of the year; their expiration is part of the “fiscal cliff” the United States is approaching. Ask students to write down their thoughts on what might happen when these tax cuts expire:

How will individuals be affected?

How might the larger economy be affected?

Will the government benefit or suffer?

Note: While this lesson is geared toward helping students understand the mathematics behind the fiscal cliff, exploring the politics behind the cliff can help frame what is happening and why. The interactive “Staking Out Positions in the Fiscal Talks” provides a brief overview of the major players in the fiscal negotiations and where they stand on issues like taxes, entitlement programs and spending cuts. The article “Seeking Ways to Raise Taxes but Leave Tax Rate As Is” gives additional background about the most recent fiscal negotiations.

Related | The article “Q&A: Understanding the Fiscal Cliff” from The Times’s Economix blog explains what might happen if the United States goes over the fiscal cliff:

Almost everyone who pays taxes would see a hit to take-home pay in the first paycheck of January. The lowest income tax rate would rise to 15 percent from 10 percent. The highest rate would rise to 39.6 percent from 35 percent. The 25 percent, 28 percent and 33 percent rates would rise to 28 percent, 31 percent and 36 percent, respectively. Most capital gains taxes would rise to 20 percent from 15 percent. The tax rate on dividends, now set at 15 percent, would jump to ordinary income tax rates, and since most dividend taxes are paid by the wealthy, that would mean a new dividend tax rate of 39.6 percent. The exemption on taxation of inherited estates would drop to $1 million from $5 million. The tax rate above that exemption would jump to 55 percent from 35 percent.

Background Vocabulary: Read the entire article with your class, then answer the questions below. You may wish to introduce students to the following words or concepts before reading: exemption, sequestration, bipartisanship.

Questions | For discussion and reading comprehension:

How will individuals be affected by the fiscal cliff? How will government programs be affected by the fiscal cliff? What are some of the specific policies involved in the fiscal cliff? What are some proposals for avoiding the fiscal cliff? What is President Obama expected to do regarding the fiscal cliff?

Activity | The phrase fiscal cliff refers to a collection of economic policies that are set to expire or be enacted at the start of 2013. These policy changes could drastically alter the economic and financial landscape of the country. This math lesson focuses on exploring two policies that directly affect individual taxpayers: the expiration of the so-called Bush tax cuts, and the expiration of the payroll tax cut.

The Bush tax cuts refer to two acts of legislation passed during the presidency of George W. Bush that effectively reduced the amount of federal income tax individual Americans paid. The acts were passed in 2001 and 2003. These tax cuts were extended by President Obama but are set to expire and are part of the impending fiscal cliff.

Have students research the federal income tax rates that were in place before and after the Bush tax cuts were enacted. (Here is a list of historical tax rates.) Have them create a table of income levels (PDF), and have them compute and compare the amounts of tax an individual at different levels would have to pay (a) under current tax rates and brackets, and (b) using the rates and brackets from 2000 (the year before the first of the two Bush tax cuts were enacted). To simplify matters, use only the “Single” status category for all tax calculations.

Keep in mind that these are marginal tax rates. That is, someone earning $100,000 in 2003 would be in the 28 percent “tax bracket,” but their income tax is not 28 percent of $100,000; they pay only 28 percent on the amount of their income above the next lowest bracket, which in this case ends at $68,800. Thus, this hypothetical individual earning $100,000 in 2003 would be taxed in the following way: 10 percent on the first $7,000; 15 percent on the amount from $7,000 to to $28,400 (a total of $21,400); 25 percent on the amount from $28,400 to $68,800 (a total of $40,400); and 28 percent on the amount from $68,800 to $100,000 (a total of $31,200). Thus, this individual’s income tax would be (0.10 * $7,000) + (0.15 * $21,400) + (0.25 * $40,400) + (0.28 * $31,200) = $22,746.

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The payroll tax cut is also set to expire at the end of this year. Individuals must pay a certain percentage of their income into Social Security. The payroll tax cut reduces the amount employees and the self-employed must pay from 6.2 percent to 4.2 percent of their total income.

Have students calculate the difference that this 2 percent makes in the take-home pay of individual earners, and have them add this information to the chart. Keep in mind that only income up to $110,000 is taxable by Social Security — no income above that amount will be taxed at any rate.

When the chart is complete, have students put the numbers in context. Have them calculate the total increase in taxes for each income level. If these tax cuts expire, how much more will individuals be paying per year in taxes? How much less money will an individual have to spend per month? Per week? As a percentage, how much more will each income level pay in taxes?

Then discuss the implications of these tax increases. How do you think they will affect the families in the lowest income brackets? How will they affect families in the highest income brackets? How will they affect the United States economy if families have less money to spend? You may want to read “Whether ‘Fiscal Cliff’ or Debtpocalypse, by Any Name, It Spells Austerity” and “A Chance to Tackle Inequality” for additional analyses of the impending fiscal crisis.

Going Further | Here are additional way to explore this topic in depth using math:

Cutting Spending: The fiscal cliff does not just include tax increases. It also currently includes a budget sequestration — broad automatic cuts in federal spending. Read “White House Details Potential Effects if Automatic Budget Cuts Go Through.” Choose five federal programs discussed in the article, write down the amount of 2013 cuts according to the article and then calculate how much the 2012 budget is for each program. Use the following excerpt to help with your calculations:

Under the terms of those cuts, most military programs face a 9.4 percent reduction, while most domestic programs would be sliced by 8.2 percent. Medicare would be trimmed by 2 percent, while other social programs — excluding Social Security — would be sliced by as much as 10 percent.

Example: The National Institutes of Health faces a $2.5 billion cut. The cut represents a 8.2 percent reduction (nonmilitary). Therefore, the N.I.H.’s 2012 budget is around $30.5 billion.

2.5 billion = x * .082 x = 30.5 billion total budget

The automatic cuts have been compared to slashing a budget “blindfolded,” because budgets are not being determined based on the needs of government programs. If you were involved in the fiscal negotiations, what recommendations would you make for cutting spending? Would you be in favor of these “blindfolded” cuts? Are there specific programs that you would recommend for cutting spending? Are there any programs that you think should maintain current spending, or even increase spending?

Raising Taxes on the Wealthy: One of the central questions in the fiscal debate, as it was during the recent presidential campaign, is: How much should the wealthy pay in taxes? Look back at historical tax rates and compare current rates with rates from previous decades, like the 1970s or 1950s. How do they compare? What differences do you notice? Then, look at the Interactive “Your Coming Tax Cut (or Not)” used in this lesson’s Warm-Up. What does the interactive illustrate about how the Bush tax cuts affected wealthy Americans?

Have students read one or more of the articles below and discuss arguments for and against increasing taxes on the wealthy. If students are in favor of increasing tax rates, they should articulate by how much and for which tax brackets. You may want to assign different articles to different students or groups:

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Considering Policy: In addition to having students explore how individuals will be affected, have them consider the policy changes from the perspective of the government. More income tax means more revenue, but how much more? Take a look at income distribution in the United States, estimate how much more total tax revenue will be generated for the federal government from these higher rates using your completed tax chart, and put this number in the context of Mr. Obama’s 2013 budget proposal. Click on the “Department Totals” button to see how the federal government spends its money on different government programs. What do you think the federal government should do with new revenues raised by increasing taxes? Should the money be used to reduce the deficit? Prevent cuts in certain programs? Increase spending in any areas?

Scaling the Budget to Household Size: The world-famous mathematician Terence Tao suggests rescaling federal budget numbers by converting $100 million to $3. This has the effect of scaling the entire federal budget of $3.54 trillion to a “household scale” of around $105,000. Have students convert the federal numbers calculated above into this “household” scale to put the numbers in a more understandable context, or have them create a scale of their own.

Common Core ELA Anchor Standards, 6-12:

Math – Numbers and Quantity

Reason quantitatively and use units to solve problems.

Math – Statistics and Probability

Summarize, represent and interpret data on a single count or measurement variable.

Reading

7. Integrate and evaluate content presented in diverse formats and media, including visually and quantitatively, as well as in words.

Speaking and Listening

2. Integrate and evaluate information presented in diverse media and formats, including visually, quantitatively and orally.

McREL Standards

Economics

6. Understands the roles government plays in the United States economy.

8. Understands basic concepts of United States fiscal policy and monetary policy.