The Fiscal Cliff Explained
“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012. U.S. lawmakers have a choice: they can either let current policy go into effect at the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – or cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe.
The oncoming fiscal cliff is a concern for investors since the highly partisan nature of the current political environment could make a compromise difficult to reach. This problem isn’t new, after all: lawmakers have had three years to address this issue, but Congress – mired in political gridlock – has largely put off the search for a solution rather than seeking to solve the problem directly. Republicans want to cut spending and avoid raising taxes, while Democrats are looking for a combination of spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve – particularly in an election year.
The most likely result is another set of stop-gap measures that would delay a more permanent policy change until 2013 or later. The election will almost certainly have an impact on the direction of future policy, particularly if one party earns a decisive victory. Nevertheless, 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 with no major economic hit.
Among the laws set to change are the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would take a larger bite, the end of the tax cuts from 2001-2003, and 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.
Possible Effects of the Fiscal Cliff
The effect 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 set to go into effect 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, $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts; $125 million from the expiration of the Obama payroll-tax holiday; $40 million from the expiration of emergency unemployment benefits; and $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, according to the J.P. Morgan report.” Amid an already-fragile recovery and elevated unemployment, the economy is not in a position to avoid this type of shock.
The cost of indecision is likely to have an effect on the economy before 2013 even begins. The CBO anticipates that a lack of resolution will cause households and businesses to begin changing their spending in anticipation of the changes, possible reducing GDP by a full half-percent in the second half of 2012.
Another way of looking at it:
Scenario 1: punt
Scenario 2: modest compromise
Scenario 3: over the cliff
Scenario 4: grand bargain
By WSJ Staff
Here are some answers to common questions about the “fiscal cliff” facing the U.S. economy. This is a revised version of the original post published earlier this year.
What is the “fiscal cliff”?
The fiscal cliff is the combination of large spending cuts and tax increases that are scheduled to be automatically enacted at the start of 2013. Bush-era income-tax cuts will expire for tens of millions of Americans, and billions of dollars of spending cuts will take effect because Congress couldn’t reach a deal last year to reduce the deficit by at least $1.2 trillion over 10 years. Democrats want a combination of spending cuts and tax increases, while Republicans want to cut spending, but don’t want to raise taxes. Both want to avoid the fiscal cliff, because it forces severe cuts, particularly in defense.
What taxes and spending are affected?
A payroll-tax holiday ends, which means a tax increase for workers of as much as 2% of wages. Income-tax rates revert to pre-George W. Bush levels, rising not only for the rich but for nearly all taxpayers. Across-the-board cuts in domestic and, particularly, defense spending are triggered.
What is the immediate cost to the economy?
The sudden rise in taxes and cuts in spending would have a harsh impact. In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts; $125 million from the expiration of the Obama payroll-tax holiday; $40 million from the expiration of emergency unemployment benefits; and $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, according to J.P. Morgan.
How would this impact growth?
The nonpartisan Congressional Budget Office projects that if the tax increases and spending cuts go into effect, the economy would contract at a 2.9% annualized rate in the first six months of 2013 and the unemployment rate would rise to 9.1% at the end of next year. The jobless rate was 8.3% in July. If the spending cuts and tax increases are averted, the economy would grow at an anemic 1.7% next year and unemployment would fall slightly to 8.0% by the end of next year.
.How worried is the Fed?
Federal Reserve Chairman Ben Bernanke has warned lawmakers about the potential effect of the “fiscal cliff,” adding that “there is absolutely no chance that the Federal Reserve would be able to have the ability whatsoever to offset that effect on the economy.” The Fed has been concerned about the fiscal cliff all year. In the minutes of its April meeting, for instance, the Fed said that if lawmakers don’t reach agreement on a plan for the federal budget, “a sharp fiscal tightening could occur at the start of 2013.” That uncertainty “could lead businesses to defer hiring and investment” and weigh on economic sentiment, officials worried at the meeting. Agreement on a long-term plan could alleviate some of that uncertainty. On Wednesday, the Fed released minutes from its July 31-Aug. 1 meeting, in which it said participants see “a sharper-than-anticipated U.S. fiscal consolidation” as a “significant downside” risk to the economic outlook.
What is the state of play in Congress currently, and what are some possible scenarios?
No final action is likely until the end of the year, when hitting the fiscal cliff is imminent, because of partisan divisions in Congress and the political risk of taking tough votes on taxes and spending ahead of the November elections. In the short term, House leaders plan a vote to extend Bush-era tax levels for all taxpayers temporarily, possibly for one year, to give the next Congress time to work on overhauling the tax system to make it more competitive with other countries. That pre-election vote likely will include a fast-track mechanism so the eventual tax overhaul will get an expedited vote next year, and won’t get hung up by parliamentary maneuvering. The badly divided Senate doesn’t appear likely to take a vote on basic tax rates until after the election. A big question is whether and how lawmakers in a lame-duck session will seek to soften the blow of scheduled spending cuts
How to prepare:
Now there are many ways to prepare for this. This is just what I think people should do to prepare.
Have a savings plan just in case.
Get something besides fiat currency
Get out of any debt you may have
Get some other type of fiat currency ex Swiss franks yen ect even maybe bitcoin
Keep your eyes on the news. In cases like this we will never know what will happen or what can happen but it pays to be prepared so keep your eyes and ears open and adopt as things progress.
Learn a skill and trade just in case. We never know how we will end up we might make it or we might have to resort to stone-age way of life. Who knows for sure but learn something a craft you can do with your hands. Like welding, carpenter , architect and so on so forth.
Have gold, silver, diamonds, rubies ect. You never know what will be valuable or what will remain valuable have those things never really loose value.
Learn to live off the grid if need be. Again you never know these days what will happen.
And finally use your best judgment when it comes to this. You know what is best for you. Not me or anyone else. Use your best judgement and adopt and over come. You can not prepare for everything being able to adopt is key and a way of life. While you can try your best you just never know what life will throw at you.