The Obama administration could blunt the economic harm caused by the “fiscal cliff” at the end of the year by using its unilateral powers over spending and taxes, for instance, by freezing how much in taxes is taken out of payroll checks, according to former senior officials and other tax and budget experts.
Beyond postponing tax increases, administration officials might also soften the blow from dramatic federal spending cuts by shifting available money toward paying immediate costs — such as government employee salaries — rather than saving for construction projects later in the year.
White House officials have yet to detail how they might handle the hundreds of billions of dollars in tax increases and spending cuts that are set to take effect if the administration and lawmakers fail to reach a deal on tackling the deficit.
But when faced with a similar situation before, the administration considered delaying scheduled tax increases by deferring changes to income tax withholding tables, according to people familiar with the matter. In 2010, when taxpayers were about to see a similar automatic increase in income taxes, top advisers to Treasury Secretary Timothy F. Geithner privately concluded that he probably had the power to put off changes to the tables under some circumstances, according to sources who spoke on the condition of anonymity to discuss the previously unreported deliberations.
If the administration were to take such emergency actions this time around, it could buy the White House and Congress more time to reach a deal, easing some of the urgency to preempt the fiscal cliff. Economists have warned that the combined effect of increased taxes and slashed spending could plunge the nation into recession.
Budget and tax experts, including people familiar with the administration’s thinking, say it could assert broad powers in the coming weeks to prevent the worst of the fiscal cliff, at least temporarily. If Mitt Romney is elected Tuesday, he could choose to continue or revise the emergency policies.
The scheduled tax hikes include increases in payroll taxes and rates for upper- and middle-income Americans, as well as an adjustment to the alternative minimum tax. These increases total about $500 billion next year and could deal a far larger blow to the struggling economic recovery than would the spending cuts, which come to about $100 billion over the same period.
Without any new actions by Congress, taxes will rise an average of $3,500 per household. Middle-class families would see an average increase of $2,000, according to the Tax Policy Center. Most people would see the impact of those tax increases in their first paycheck, because employers usually withhold a worker’s estimated taxes.
But the Treasury Department could try to blunt the impact by freezing withholding tables at 2012 levels. The law gives the Treasury secretary the authority to set withholding tables at his discretion, though they are supposed to comply with the law.
“This is a gray area,” said Gregory F. Jenner, a senior tax official in the George W. Bush administration. “I think it’s possible. Who’s going to challenge him?”
Jenner said the move might not be wise but is still an option “if they have a plausible, defensible reason. There is not a rigid set of rules.”
(If the administration were to delay changes to the withholding tables, taxpayers would still owe the full amount of taxes under law at the end of the year.)
In late 2010, Obama administration officials feared that the weak economy was about to take a big hit from scheduled tax increases on middle- and upper-class earners. Republicans had just seized control of the House in midterm elections, and it wasn’t clear whether a bipartisan deal could be reached to head off the tax increases before they took effect at the start of the new year.
The White House and lawmakers were furiously negotiating. Treasury Department lawyers examined whether Geithner could freeze the withholding tables, according to people familiar with the matter.
The lawyers didn’t agree on the circumstances under which Geithner could act. Some said he could act only if there was near-certainty that Congress would prevent rates from rising. Others argued that he could defer changes to the tables if there was simply a high probability that negotiators would strike a deal in the new year to extend the tax cuts. Geithner’s top advisers concluded that he could probably postpone changes to the tables under those somewhat looser circumstances, but a deal between the parties in December 2010 averted the need to make a final decision.
Spokeswomen for the White House and the Treasury Department declined to comment on what the administration would do this time around.
Although the administration could soften the immediate impact of higher income tax rates, there would be less latitude for the alternative minimum tax and the payroll tax cut. The payroll tax would be increased immediately, costing the average family about $80 per month. The AMT, which affects nearly 30 million upper-middle-income households, would become an issue for people as they begin to file their taxes, because it affects 2012 income.
The administration could also have power to shape the automatic spending cuts, known as sequestration, so the initial hit to the economy is not that great.
The law calls for $93 billion in cuts to defense and domestic spending in the fiscal year ending Sept. 30, 2013, but much of that spending, though technically allocated in 2013, would be carried out in later years. As a result, the government must cut only $45 billion through the end of the fiscal year.
And the government can postpone many of these cuts until later in the year, though not indefinitely.
“The government has a moderate amount of flexibility to mitigate the immediate effect of sequestration,” said Richard Kogan, a senior fellow with the Center on Budget and Policy Priorities and former Obama administration budget official. “But over the long run, there’s no getting around the fact that when funding is cut, you must do less.”
Kogan said federal agencies could move cash around at the beginning of the year, fully funding pressing needs by using money marked for spending later in the year, betting that a fiscal deal between the White House and Congress would eventually restore normal funding.
“The parts [of government] that have the most flexibility are those that engage in construction, procurement or research-type projects — projects where the timing isn’t critical but what really matters is that a multi-year plan is ultimately carried out,” he said. “Because the timing isn’t critical, they have the most flexibility to defer the effects of the cuts.”