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Just how steep is the looming tax cliff?

It’s been labeled the “fiscal cliff,” the “tax cliff,” “taxmageddon,” and the “ticking tax bomb.” I prefer to call it playing dangerous politics with the economy.

What is this cliff, and just how steep is the potential drop?

While the game is politics with an election fast approaching, the unfortunate reality is that tax increases scheduled to kick in at the end of this year have a very real effect on the decisions made by entrepreneurs and investors, now and in the future, and therefore, on economic growth and job creation.

Policy inaction overwhelmingly is due to the President Obama’s insistence on imposing tax increases on upper-income earners. That’s pandering politics, and very bad economics.

Let’s consider key details of the pending tax increases, and then estimates as to how badly the economy would be hit if they were allowed to occur.

First, nearly all personal income tax rates would rise, with the bottom rate climbing from

10 percent to 15 percent, and the top rate from

35 percent to 39.6 percent. Factor in the Medicare payroll tax, including the ObamaCare tax increases, and the top rate climbs from 37.9 percent to 43.4 percent. Throw in state taxes, and the combined tax rate would approach 50 percent.

Remember that most small businesses – the innovators and job creators – would be hit by this personal income tax increase. According to the Joint Committee on Taxation, 95 percent of businesses pay the personal income tax, rather than the corporate income tax, as they are pass-through entities, such as sole proprietors, partnerships, S Corporations, and LLCs.

Second, the capital gains tax rate would increase from 15 percent to 23.8 percent, and the dividend tax rate would jump from 15 percent to 43.4 percent. If we’re serious about getting the economy back on track, then greater private sector risk-taking is critical. Raising taxes on investment means fewer incentives and resources for investing in new and expanding businesses.

Third, the death tax would rise from a top rate of 35 percent to 55 percent, while the exemption level would be reduced from $5.12 million (indexed for inflation) to $1 million (not indexed). As a result, more investors and small businesses would have to deal with both the Grim Reaper and the Tax Man at the same time, with the government looking to grab more than half of business and investment assets, for example. How can that possibly be good for investment, business growth and jobs? It cannot.

Fourth, married couples would get hit by a reinstated marriage penalty due to both a smaller standard deduction and higher tax rates. That means a smaller family budget.

Fifth, the alternative minimum tax would expand greatly, moving from affecting about

4 million taxpayers in 2012 to a staggering

31 million in 2013. Taxpayers in states with high state and local taxes, and therefore, higher deductions on their federal taxes, like New York, would face the biggest tax increases.

In an Aug. 1 analysis, the Tax Foundation broke down the size of the overall tax increases (or the savings if the current tax system were extended) for one year on a state by state basis. As a share of state income, Mississippi’s

3.15 percent tax increase would be the smallest, and New York’s would be the biggest at 8.05 percent.

Especially during one of the worst economic recoveries on record, this should be enough to scare lawmakers into stopping this “taxmageddon” that has been estimated at a one-year tax increase topping $400 billion dollars. But apparently, it’s not.

Well, what would the impact be on the broader economy? The Congressional Budget Office has predicted that a recession would result in the first half 2013.

A study released by the Heritage Foundation in July estimated that “an additional 2.8 million people unemployed, with large losses in California, Texas, Florida, and New York.”

As for small business, that Heritage analysis concluded that the increase in the top tax rate “would lower the probability that a small business entrepreneur would add to payrolls by roughly 18 percent. For those that do manage to hire, the growth in payrolls would be diminished by more than 5 percent. The increase in tax rates would reduce the probability that a small business undertakes expansion by nearly 15 percent, and reduce the capital outlays of those that do by almost 20 percent.”

These estimates of increased chances for recession, increased unemployment, and restrained investment and job creation by small business are not surprising. Economic theory and history tell us that this is exactly what happens when more resources are taken from the private sector, and taxes are changed to reduce incentives for risk-taking.

Unfortunately, we’ll have to wait until the very last minute, i.e., until after the November elections, to see whether or not small businesses, the economy and job seekers will be driven off the cliff.

— Raymond J. Keating, chief economist for the Small Business & Entrepreneurship Council, and author of “Chuck” vs. the Business World: Business Tips on TV.

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