“Fiscal cliff” is
the popular term used to describe the situation that the U.S. government
will face at the end of 2012, when the terms of the Budget Control Act
of 2011 go into effect.
The things that are slated to happen are a combination of tax increases and cuts to government spending that when considered together, have the potential to cause a lot of problems for businesses in the US and perhaps - the world.
Among the laws set to change at midnight on December 31, 2012, are:
1) The end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers)
2) The end of certain tax breaks for businesses
3) Shifts in the alternative minimum tax that would take a larger bite out of paychecks
4) The end of the tax cuts that began in 2001-2003 (also known as the Bush tax-cuts)
5) The beginning of taxes related to President Obama’s health care law.
At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. Approximately 1,000 government programs - including the defense budget and Medicare are in line for deep, automatic cuts.
In dealing with the 'fiscal cliff', U.S. lawmakers have a choice among three options, none of which is very attractive:
Republicans want to cut spending and avoid raising taxes. They see a need to cut spending on programs that many people have relied on for years, which provide financial assistance. They're concerned that tax increases will encourage businesses to look to places like China where corporate taxes are lower. Republicans believe that increasing taxes will discourage new business start-ups and force companies to layoff or terminate employees, hurting a fragile economy.
Democrats are looking for a combination of spending cuts and tax increases. Democrats believe that corporations and wealthy individuals have a responsibility to pay a larger share of the bill for keeping the goverment running and they believe that spending cuts to programs that provide financial assistance are not feasible.
Although both parties want to avoid the fiscal cliff, compromise is difficult to achieve.
Congress has had three years to deal with the problem and work out a compromise, but has failed in every attempt, due to a reluctance by both sides to compromise on strongly held ideologies. The election did nothing to change the make-up of power in Washington. All the same players are still in the game and they're reading from the same playbook.
Personally, I doubt that a compromise will be reached before the end of the year. The two sides are too far apart in their views. In early discussions, it seems neither side is willing to give in on their demands. I expect that we'll see a stalemate and of course - finger-pointing will ensue when they're asked why nothing was accomplished. As a side note - the next Congress won't be sworn in until January 3.
The most likely result is another set of stop-gap measures that would delay a permanent policy change until 2013 or later.
The non-partisan Congressional Budget Office (CBO) estimates that if Congress takes the middle ground – extending the Bush-era tax cuts but cancelling the automatic spending cuts – the result, in the short term, would be modest growth but no major economic hit.
Possible Effects of the Fiscal Cliff
If the current laws slated to go into effect are not changed, the impact on the economy could be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the CBO estimates that the policies would cut gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession (i.e., negative growth).
At the same time, it predicts unemployment would rise by almost a full percentage point, with a loss of about two million jobs.
A Wall St. Journal article from May 16, 2012 estimates the following impact in dollar terms: “In all, according to an analysis by J.P. Morgan economist Michael Feroli:
1) $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts
2) $125 million from the expiration of the Obama payroll-tax holiday
3) $40 million from the expiration of emergency unemployment benefits
4) $98 billion from Budget Control Act spending cuts.
In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that. Amid an already-fragile recovery and high unemployment, the economy is not in a position to avoid this type of shock.
Having said all this, it's important to keep in mind that while the term “cliff” indicates an immediate disaster at the beginning of 2013, the impact of the changes - while destructive over a full year - will be gradual at first. Furthermore - Congress can act to change laws retroactively after the deadline. As a result, the fiscal cliff may not immediately impact the economy, even if a deal is struck well into 2013.
Links:
Much of the information cited in this note can be found here:
http://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htm
The things that are slated to happen are a combination of tax increases and cuts to government spending that when considered together, have the potential to cause a lot of problems for businesses in the US and perhaps - the world.
Among the laws set to change at midnight on December 31, 2012, are:
1) The end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers)
2) The end of certain tax breaks for businesses
3) Shifts in the alternative minimum tax that would take a larger bite out of paychecks
4) The end of the tax cuts that began in 2001-2003 (also known as the Bush tax-cuts)
5) The beginning of taxes related to President Obama’s health care law.
At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. Approximately 1,000 government programs - including the defense budget and Medicare are in line for deep, automatic cuts.
In dealing with the 'fiscal cliff', U.S. lawmakers have a choice among three options, none of which is very attractive:
- They can do nothing and let the scheduled changes go into effect. The plus side of this is that the budget deficit would be cut in half. The downside is that we would see the elimination of millions of jobs, and a removal of capital from the economy, which would weigh heavily on growth and drive the economy deeper into a recession.
- They can cancel some or all of the scheduled tax increases and spending cuts. The upside of this is that we would retain most of the jobs that would be lost if the changes were allowed to go into effect. The downside is that we would add to the deficit and increase the odds that we could face a crisis similar to that which is occurring in Europe.
- They could take a middle course, opting for an approach to address the budget issues to a limited extent, but that would have a more modest impact on growth.
Republicans want to cut spending and avoid raising taxes. They see a need to cut spending on programs that many people have relied on for years, which provide financial assistance. They're concerned that tax increases will encourage businesses to look to places like China where corporate taxes are lower. Republicans believe that increasing taxes will discourage new business start-ups and force companies to layoff or terminate employees, hurting a fragile economy.
Democrats are looking for a combination of spending cuts and tax increases. Democrats believe that corporations and wealthy individuals have a responsibility to pay a larger share of the bill for keeping the goverment running and they believe that spending cuts to programs that provide financial assistance are not feasible.
Although both parties want to avoid the fiscal cliff, compromise is difficult to achieve.
Congress has had three years to deal with the problem and work out a compromise, but has failed in every attempt, due to a reluctance by both sides to compromise on strongly held ideologies. The election did nothing to change the make-up of power in Washington. All the same players are still in the game and they're reading from the same playbook.
Personally, I doubt that a compromise will be reached before the end of the year. The two sides are too far apart in their views. In early discussions, it seems neither side is willing to give in on their demands. I expect that we'll see a stalemate and of course - finger-pointing will ensue when they're asked why nothing was accomplished. As a side note - the next Congress won't be sworn in until January 3.
The most likely result is another set of stop-gap measures that would delay a permanent policy change until 2013 or later.
The non-partisan Congressional Budget Office (CBO) estimates that if Congress takes the middle ground – extending the Bush-era tax cuts but cancelling the automatic spending cuts – the result, in the short term, would be modest growth but no major economic hit.
Possible Effects of the Fiscal Cliff
If the current laws slated to go into effect are not changed, the impact on the economy could be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the CBO estimates that the policies would cut gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession (i.e., negative growth).
At the same time, it predicts unemployment would rise by almost a full percentage point, with a loss of about two million jobs.
A Wall St. Journal article from May 16, 2012 estimates the following impact in dollar terms: “In all, according to an analysis by J.P. Morgan economist Michael Feroli:
1) $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts
2) $125 million from the expiration of the Obama payroll-tax holiday
3) $40 million from the expiration of emergency unemployment benefits
4) $98 billion from Budget Control Act spending cuts.
In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that. Amid an already-fragile recovery and high unemployment, the economy is not in a position to avoid this type of shock.
Having said all this, it's important to keep in mind that while the term “cliff” indicates an immediate disaster at the beginning of 2013, the impact of the changes - while destructive over a full year - will be gradual at first. Furthermore - Congress can act to change laws retroactively after the deadline. As a result, the fiscal cliff may not immediately impact the economy, even if a deal is struck well into 2013.
Links:
Much of the information cited in this note can be found here:
http://bonds.about.com/od/Issues-in-the-News/a/What-Is-The-Fiscal-Cliff.htm
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