Everything You Need To Know About The Fiscal Cliff

The Fiscal Cliff is coming, and only our elected officials can stop it.

You can argue among yourselves which part of that sentence is the scariest, but on December 31st of this year the United States is set to head over the “Fiscal Cliff”. Here is what you need to know about it:

What is the “Fiscal Cliff”?

The term “Fiscal Cliff” – coined by Fed Chairman Ben Bernanke – is basically an economic version of Hurricane Sandy, where all the right stars align to make an already powerful and damaging force all that much more destructive.

The forces combining to create the fiscal cliff are numerous:

1. The Bush-era tax cuts are set to expire on December 31st of this year. If they are not extended income tax rates will rise by ~3% across the board. The 10% tax bracket will also disappear.  In addition the child tax credit will be cut in half, estate taxes return to 2001 levels, taxes on capital gains and dividends rise and breaks for education, retirement savings and more completely disappear.  For a more detailed look, check out this table from taxfoundation.org

bush tax cuts fiscal cliff

2. The 2% payroll tax holiday and extended unemployment benefits that President Obama chose to extend in February are also set to expire on December 31st.

3. The Alternative Minimum Tax (AMT) patch also expires which will subject about 32 million taxpayers to the AMT which will raise taxes by about $3,700 on those affected.  The “Buffett Rule” would be a replacement for the AMT, however chances are slim that become law before the fiscal cliff hits.

4. Medicare payments to doctors will be reduced – Part of the 1997 Balanced Budget Act the ‘Sustainable Growth Rate Formula’ calls for an enormous reduction in Medicare payments to doctors. Lawmakers have delayed this for years and years, but if no action is taken this time around, Medicare payments to doctors could drop by 27%.

5. Automatic federal spending cuts kick in on January 1, 2013. As part of the debt ceiling debacle earlier this year $1.2 Trillion (yes, with a T) of forced spending cuts would take place over the next 10 years. These cuts are split evenly between military, and discretionary spending and were designed to be so large that they would motivate Congress to act, as neither party favors cuts this large (2013’s share would be a hair over $109 Billion in cuts).  It is important to note that congress passed this never intending for it to actually go into effect! 

6. “Obamacare” starts to get paid for. While the plan is slowly rolled out over a six-year period, much of how Obamacare is paid for rolls out January 1, 2013. This includes an expiration of the Bush tax cuts on only those earning over $200,000 ($250k jointly). A 0.9% tax increase on high earners and a Medicare tax on capital gains income.

7. The debt ceiling will once again be approached near the end of 2012, and Congress will need to act in order to raise the ceiling.  If you recall, it was Congress playing hardball with the debt ceiling in 2011 that caused S&P to cut the debt rating of the U.S. The debt ceiling isn’t an as critical part of the fiscal cliff, but it would be naïve to believe that it won’t be part of the negotiations.

What Happens If We Go Off The Fiscal Cliff?

You may read the above points and think that they’re not all that bad, in fact, letting many of the above expire may even seem like a good idea!  The problem is letting it all happen at once. Neither Democrats, Republicans, liberal, or conservative economists want to see all this happen at the same time. Especially when our economy is still in a somewhat fragile state.

The Congressional Budget Office (CBO) currently predicts the economy will grow by 1.7% in 2013. If our fearless leaders fail to act on the fiscal cliff, the CBO predicts the economy will shrink by 0.5% next year. Economic growth slows down, and unemployment will start to rise again. Basically, instead of the economy continuing its slow, methodical recovery we could be shocked right back into a recession before the economy shakes off the effects of the fiscal cliff.

Predictably, there’s always a catch to these things. The catch of the debate is that extending the policies listed above and avoiding the fiscal cliff isn’t necessarily a better option. The Bush tax cuts probably should be allowed to expire, and the Government does need to cut spending and work on reducing the amount of debt it’s carrying.

So What’s Going To Happen?

Honestly, I don’t know. Our politicians need to make some true hard choices and get some big problems solved, which I think we can all agree hasn’t been their forte in recent memory.

President Obama doesn’t need to win any more elections, so he is probably going to be more apt to stick to his guns on what he thinks the best course of action is. It’s a safe bet to assume he won’t be a fan of a lot of the spending cuts that will be proposed in negotiations.

House Republicans have played hardball politics with our economy before (see the 2011 debt ceiling fiasco) and at present seem unwilling to budge on allowing any form of tax increase.

Speaker Boehner and President Obama have said the right things in recent days, and both seem ready to work together to get this problem solved. But before they actually sit down at the bargaining table it’s nothing but political posturing.

If I had to guess what will happen, I would guess that the President and Congress reach a short-term duct tape solution to the fiscal cliff, once again putting off the hard choices. But maybe that’s just me being overly cynical. Maybe President Obama and Speaker Boehner really are willing to work together and reach a “Grand Bargain” that strikes a bi-partisan balance between fiscal responsibility and economic growth. Maybe.

 

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2 Responses to Everything You Need To Know About The Fiscal Cliff

  1. Brent says:

    Do you agree with this? Letting the Bush tax cuts expire on the 250k+ households will solve half the cliff? It seems unlikely to me given the idea mentioned above that this money would be used to pay for “obamacare”. Can it really do both?

    http://finance.yahoo.com/news/obama-us-cant-afford-across-190727792.html

    • Jay says:

      I think the notion that it “solves half the cliff” is that half the problem is the bush-era tax cuts expiring on EVERYONE. With the other half being the gigantic spending cuts kicking in at the same time. Getting a resolution on the tax issue would solve half of the fiscal cliff issue, not half of whatever problems/deficits they need to tackle.

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