Congress misses fiscal crisis deadline amid ongoing talks – so what does it mean?

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Even if you didn’t touch a drop of alcohol on New Year’s Eve, you could be waking up Tuesday morning with the makings of a huge financial headache.

With Congress missing the midnight deadline for averting the fiscal crisis, Americans are now on the receiving end of a wave of tax hikes – at least for the time being. Lawmakers are scrambling, with the Senate passing legislation early Tuesday morning, to halt most of those increases. The House returns at noon to begin consideration of the proposal. But the pain over any prolonged political indecision in Washington could be felt for months.

So what’s this mean for the average American?

In the short term, taxes will go up. By how much and for how long is the question.

Congress has the technical ability to rewind the clock and effectively undo any tax increases, but until lawmakers agree on a compromise and it’s signed by President Obama, Americans are left paying for the pricey political stalemate playing out in Washington.

Most will feel the first fiscal sting in their January paychecks. Starting today, a 2-percentage-point payroll tax holiday expires. That means workers will have 6.2 percent of their wages withheld to pay for Social Security, up from 4.2 percent over the past two years.  For households earning $50,000, they will have to pay $1,000 more in taxes in 2013. Despite both Democrats and Republicans saying they don’t want to tax the middle class, this holiday is unlikely to be extended.

Beyond the expiration of the payroll tax cut, paychecks could get even smaller in a matter of weeks if Congress does not pass legislation.

Overnight, the Internal Revenue Service told payroll companies they would have until Feb. 15 to update their withholding tables, allowing them to use 2012 rates until then while making clear that payroll tax rates would certainly rise. But the reality is that a host of other tax provisions have technically expired and with them come renewed fears about the economy if unaddressed.

“What won’t change is the fact that the world’s largest economy is about to start a year and no one knows what the tax rates will be,” said Peter Tchir, founder of Connecticut-based TF Market Advisors. “There are lots of other uncertainties, but for me, that is the most basic one to look at. How can a country be so inept or corrupt in its governance that we can start a year with so much uncertainty?”

At the heart of the tax debate are the rates put in place by President George W. Bush. The 2001 rates came with a sunset clause of 10 years; follow-up legislation in 2003 was also set to expire around the same time. The tax rates on income, capital gains, dividends and estates were originally set to go back last year to those under President Clinton. But in 2010, Obama and Congress extended the rates for an additional two years – pushing their expiration date to Jan. 1, 2013.

With all these provisions expiring, the Tax Policy Center estimates that households making between $50,000 and $75,000 would see a roughly $2,300 tax increase in 2013. That jumps to more than $3,500 for families making between $75,000 and $100,000.

At first, families would see only a fraction of that should employers begin to withhold the extra amount.

But the impact would spread. According to analysts at Bank of America Merrill Lynch, the expired tax rates could eventually hit the housing industry hard. Struggling homeowners who had faced foreclosure or had trouble making their mortgages were given a helping hand with the lower rates.

“Going over the cliff has many secondary, largely ignored, negative impacts, including tax changes that could damage the housing recovery, as well as negatively impact education and alternative energy, among many others,” Bank of America analysts said in a research note.

“In the long term, if nothing concrete is hammered out soon, investor confidence could dive and the country’s fragile economy could be pulled into another recession. Uncertainty in the market would also create a trickle-down effect that will cause problems for federal agencies, payroll processors, tax filers and thousands of other government workers who could be furloughed or lose their jobs.”

Congress has only a limited amount of time to get the job done before they’re faced with more economic deadlines.

As part of the framework for a fiscal deal, lawmakers pushed off a permanent decision on looming spending cuts another two months. That will have to be dealt with.

And in February, the new congressional class will need to come to an agreement over the debt ceiling – the country was poised to hit the debt ceiling on Monday, though the Treasury Department took emergency measures to buy more time. The last debt-ceiling showdown took place over the summer of 2011 and rattled credit-rating agencies and investors.

It won’t get easier in March when a six-month budget resolution funding the fiscal 2013 federal operations is scheduled to run out. If lawmakers can’t come to a compromise there, the government is at risk once more for a shutdown.

If Congress does pass a final fiscal deal in the coming days, it is likely some sliver of top earners will see a major income tax hike. The latest proposal would raise taxes on households making above $450,000, though that threshold could be amended by House lawmakers.