Higher taxes and federal spending cuts would begin to hit all Americans Jan. 1. Here are ways to cope with the 'fiscal cliff.'
The "fiscal cliff" – that perfect storm of mandatory budget cuts, expiring tax cuts, and new taxes – looms with all the finality of a New Year's countdown clock.
Unless Congress acts by Jan. 1, $600 billion to $800 billion would be cut from the federal deficit. Such a cut – about 20 percent of federal spending – dwarfs any reduction since 1947, when the United States was winding down wartime spending. Even if Congress reaches a compromise, Americans are sure to feel the pinch at some point.
"The drain of this money from the private economy may mean a serious economic slowdown, as if the economy ran into a wall," says Mark Waldman, a financial adviser in Vienna, Va., and executive in residence at American University.
Here are three ways to mitigate the effects of going off the cliff:
1. Taxes: The fiscal cliff comprises several tax changes, including the expiration of Bush-era and payroll tax cuts, and the introduction of new taxes to pay for Obamacare. That would amount to more than a $500 billion tax increase, according to the Urban-Brookings Tax Policy Center. Will Congress ring in 2013 by dunning each household an average of nearly $3,500?
If taxes are likely to go up next year, it makes sense to take as many tax breaks as you can and pay as much tax on income this year as you can. Of course, there's bound to be plenty of uncertainty over which taxes will go up. That means market volatility, says Peter Hayes, managing director and head of BlackRock's municipal bond group in Princeton, N.J. "Take advantage of any overselling or overbuying that occurs."
Mr. Waldman is less optimistic. "Anyone who's not scared doesn't understand the problem," he says. He recommends short- to intermediate-term bonds, so a sudden rise in interest rates wouldn't hit so hard, he says. "In stocks, the safest place to be is in world-leading, dividend-increasing companies, large multinational firms that not only [pay] dividends every year but increase them."
Households should cut expenses, he adds. Set aside a rainy day fund if you don't have one yet.
2. Employment: Mandatory budget cuts would cut equally into defense and nondefense jobs. A George Mason University report estimated that the cuts would trim the nation's gross domestic product by $215 billion and cost 2.14 million jobs.
"We're already seeing a reduction in hiring, an increase in layoffs, and a cautiousness across the federal contracting community," says Jenessa Hoffman, president of Potomac Recruiting in Arlington, Va. With so many federal contractors, Maryland and Virginia have the most to lose, but spending cuts would hit nationwide.
Many jobs could be at stake, so update your résumé. "You never know when you're going to meet someone who provides an opportunity, and you don't want to spend a weekend pulling your résumé together," says Ms. Hoffman. Participate on social networking sites to boost visibility. Consider job havens like IT and health care.
3. Health care: If the 2 percent cut in Medicare goes through, 496,000 jobs would be lost in the first year, says a report by the American Medical Association (AMA), the American Hospital Association, and the American Nurses Association. That hits communities as well as facilities.
There are access concerns, too: "Medicare payments to physicians have been frozen for the last 10 years while practice costs have gone up," says Jeremy Lazarus, AMA president. "This kind of cut could impact physician decisionmaking about seeing new Medicare patients."
Strategies to avoid Medicare cuts are limited. Mr. Lazarus suggests that the public put pressure on Congress to repeal the cuts and eliminate the current formula that would lower Medicare payments an additional 27 percent. Others suggest a wholesale reform of the Medicare system.