The “Fiscal Cliff” Explained

Aug 2012

The Fiscal Cliff is a popular term used lately in the media to describe a set of circumstances that we and the government face at the end of 2012. U.S. lawmakers have to choose between letting the current fiscal policy remain in effect at the beginning of 2013 or cancel some or all of the scheduled tax increases and spending cuts by passing legislation by December 31, 2012.

If nothing is done to change the current fiscal policies, the following big-picture items would take effect in 2013:
• Temporary payroll tax cuts would end (which would result in a 2% tax increase for workers).
• The tax cuts from 2001-2003 which impact a variety of areas including capital gains, dividends, estate taxes and AMT (Alternative Minimum Tax) would end.
• At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 would begin to go into effect. This is referred to as sequestration.

Further, the Congressional Budget Office (CBO) estimates that the above items would cut the Gross Domestic Product (GDP) by four percentage points in 2013, thus, pushing the economy into a recession. They also predict that unemployment would rise a full percentage point.

Some have referred to the fiscal cliff as an elaborate game of chicken and I tend to agree with that analogy. Like most political issues, the solutions have a way of being delayed and turned into political currency for the next big election. This is why we are now hearing much more about the fiscal cliff on a regular basis. No doubt, the fiscal cliff will be fodder for the political conventions this week and next.

Republicans want to cut spending and avoid raising taxes, while Democrats want a combination of spending cuts and tax increases on “only the rich”. Ultimately, I believe there will be a compromise, but most likely not until after the November election. Furthermore, I think it is highly unlikely that the compromise will be anything more than another short-term solution or collection of stop-gap measures. I suspect the difficult, yet necessary, solutions will be kicked down the road yet again.

There will be a little less than two months post-election to do something to avoid that fiscal cliff and I have little doubt that the political horse-trading will go into over-drive as we close out the year regardless of who wins the presidential ticket.


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