What is the Fiscal Cliff?

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Oceanside CliffYou have may heard a lot of talk lately about this “fiscal cliff.” It refers to yet another battle over the debt ceiling, a lot of automatic cuts and tax law expirations, and generally a “perfect storm” of fiscal policy that paints a bad economic picture. Coupled with all the political fighting, a Presidential election, and you have yourself a bad scenario with a potentially bad outcome.

They call it a fiscal cliff because fiscal policy refers to using taxation and spending to influence the economy (as opposed to monetary policy, which uses the monetary supply to influence the economy) and all of these problems are fiscal problems. They’re the result of politicians kicking the proverbial can down the road, implementing extensions rather than making a decision for the future. I don’t blame them, it’s hard to make these decisions and get them passed in such a partisan environment.

But that doesn’t help us understand what it is. Here’s the fiscal cliff, as I understand it:

Bush Tax Cuts Expiring

You may remember a couple years ago when we first talked about the expiration of the Bush tax cuts. If you’re math is as good as mine, it looks like our two year extension is up but this time President Obama has stated that he will not extend it to families earning $250,000 or more. Senate Democrats aren’t sure if they want that target income to be $1 million or $250,000. Either way, tax rates would be set to go up significantly if nothing were done.

Lastly, there are around 50 “temporary” tax breaks (the term temporary is always up for debate with Congress!) for businesses and individuals that would expire and have varying effects on taxpayers. The most notable is a fix to the Alternative Minimum Tax (AMT) fix that would be removed, which is estimated to cost the average taxpayer about $3,000 (according to the Tax Policy Center).

On a smaller note, the payroll tax cut is also expiring this year. You may not have noticed it but instead of paying 6.2% to Social Security and Medicare, you were only paying 4.2%, a reduction of 200 basis points. The payroll tax cut was extended by the Middle Class Tax Relief and Job Creation Act of 2012, but that piece expires at the end of the year.

Debt Ceiling Looming

Didn’t it seem like we were talking about the debt ceiling just a year ago? That’s because we were. 2011 was marked by a lot of political battles over the debt ceiling as Republicans took control of the House while Democrats retained control of the Senate. The limit of $14.29 trilling was reached in May 2011 but the Treasury was able to extend government services until August 2nd. An agreement was reached, a piece of which we’ll discuss shortly, to increase it to $15.2 trillion just a few days before we’d hit the ceiling. That limit increased again to $16.4 trillion in January of this year, but we’ll hit that limit at the conclusion of 2012 (though the Treasury says it can extend it into early 2013).

Automatic Spending Cuts

As part of the debt ceiling deal reached last year, both parties agreed to a set level of discretionary spending for 2013 at $1.047 trillion. This would exclude programs like Medicare and Social Security. If that holds, it’s a cut of $97 billion in spending, half coming from defense. That’s a 10% cut in defense, 8% from non-defense discretionary, though how those cuts would be implemented are not yet known. The cuts would continue to the tune of $1.3 trillion over ten years. Unless something is done, these cuts are automatic and could send reverberations throughout the economy as it would invariably result in a loss of jobs.

What’s the impact of all this? The Congressional Budget Office estimates that if nothing is done, the economy would shrink by 1.3% for the first half of 2013. Not fun.

(Photo: aussiegall)

{ 7 comments, please add your thoughts now! }

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7 Responses to “What is the Fiscal Cliff?”

  1. eric says:

    Just another day as a US citizen right, Jim? 😉

  2. Gotta love politics. The 2% cut is actually just on social security. We still pay 1.45% for Medicare. Hopefully both sides can get together and quit kicking the can so we can get back to business and not worry about what things will look like next year.

  3. Ben says:

    There is an ancient saying that comes to mind in times like this. It says Do not move an ancient boundary marker. Just because you do not understand why a limit was put in place does not mean there is no reason for it to be there.
    The debt ceiling was put in place to save us from falling off the debt cliff. Or as another economist described it as The Debt Wall.
    Even if we eliminated all tax breaks for everyone we still could not afford the interest on the debt. Raising taxes by the billions will not help us even keep up the payments on the trillions!
    Arthur Laffer said it best, “People do not work, consume, or invest to pay taxes. They work and invest to earn after-tax income…”
    So if you increase tax rates on the 1% or even the 10% top earners you still wont scratch the surface of the debt. You may have even less federal revenue because people will maximize their tax avoidance strategies to protect themselves and their families from being plundered by an irresponsible and immoral Government. Do you want to take money away from your children to fund another Solyndra or Fast and Furious legal defense fund?

  4. As Ben alluded to, no matter how much we raise taxes, we will still be in debt, still heading towards more debt. We have to spend less than we take in, I seriously don’t understand why the government can’t realize that.

    Oh wait, there are literally millions of Americans who have done the same thing with credit cards. I don’t see how anyone could spend more than they have in their bank account on non-essential purchases, but maybe that’s just me..

    • Ben says:

      Sadly, you are correct. The financial problems of the government mirror those of the private sector. Yet there are controls in place to stop consumers that borrow but do not pay back. Lenders can refuse them and their credit ratings sink. But when our elected officials keep the federal reserve printing trillions and trillions of dollars with no thought about the consequences then anyone who questions it is vilified. But if the general population were to print counterfeit money they are pursued and prosecuted to the fullest extent of the law.

  5. bill says:

    no budget in 3 years. Following same road as Greece and Spains economic policies, and every democrate follows king oboma without any consciense of how the USA will survive. What a country!!!!!!

  6. Doomsday prepareer says:

    First off , I would like to say how embarrassing it is for Americans or anyone to be in this situation. As several others have stated you CAN NOT increase revenue by spending money. For allowing our government ( president ) to continue a term in office is completely ridiculous. Why do or should AMERICANS tolerate being in this poor of shape as an economy. I am an avid motorcycle enthusiast and my dad always tells me its not if I wreck and get hurt its when. Well, history has and always will repeat itself. It will happen and in most cases worst. This is also a good example of what will happen to the USA. I’M Ready, Are you. People need to listen, learn, and remember the past to protect the future. There are so many things to change in this country we should not be faced with debt or Americans out of work. There are many you couldn’t make work much less not be able to find work. We need to teach our children.

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