Congress is trying to solve an impending fiscal problem – a sudden increase in Federal tax revenues paired with a decrease in spending. This “Fiscal Cliff” means that the year’s spending deficit will drop by approximately half beginning in 2013.
While ordinarily that might be considered good news, the Council of Foreign Relations website says that analysts warn the situation could spell danger for the U.S. economy no matter what Congress does.[1] The Congressional Budget Office (CBO) states that the expected $503 billion budget contraction might send the U.S. into a recession if Congress fails to act. Finally, the International Monetary Fund (IMF) says U.S. fragile financial conditions present a risk to global economic stability.[2]
What is the Fiscal Cliff?
Certain tax measures are set to expire December 31, 2012, or start in 2013: [3]
- The Bush tax cuts expire, raising tax rates on income for the wealthy, estates, and capital gains.
- The 2% Social Security tax holiday expires, increasing FICA from 4.2% to 6.2%.
- The Research and Experimentation tax credit expires.
- The Affordable Care Act health care reform provisions will start increasing tax rates on high-income earners.
New spending cuts for 2013 are another part of the equation:
- Budget Control Act spending cuts take effect, with half coming from defense and half from non-defense budgets.
- Extended Unemployment Benefits end.
- The Medicare “Doc.Fix” would decrease the rates Medicare pays physicians by nearly 30%.
The third component of the equation is the Debt Ceiling. The Federal debt is now capped at $16,39 trillion, which will likely be reached in the first months of 2013. Failure to arrive at a consensus could have devastating consequences. In August of 2011, for example, the Debt Ceiling fight resulted in a downgrade in the U.S. credit rating by Standard and Poor’s.
The effects of the three components together could spell disaster. Top key player Republican House Speaker John Boehner met with President Obama to offer Democrats a concession on the issue tax increases for higher-income Americans, coupled with a demand that President Obama and Democrats agree to major entitlement cuts.[4] Obama has not said yes to that and Boehner has accordingly accused the President of “stalling” the talks.[5]
The Council of Foreign Relations warns that “failure to make the hard but necessary choices now on our own terms will lead to much harder and severe choices later.”[6] The CFR further warns that increasing national debt levels could trigger higher U.S. borrowing costs and further downgrade the nation’s credit rating. This could have a worse impact than the 2011 market fallout!
[1] http://www.cfr.org/economics/fiscal-cliff/p28757, Retrieved December 15, 2012.
[2] http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/text.pdf, page xxvii, Retrieved December 15, 2012.
[3] http://www.cfr.org/economics/fiscal-cliff/p28757, Retrieved December 15, 2012.
[4] http://news.yahoo.com/night-talks-obama-boehner-meet-fiscal-cliff-223655465–finance.html, Retrieved December 15, 2012.
[5] http://www.voanews.com/content/house-speaker-boehner-blames-obama-for-stalled-fiscal-cliff-talks/1564507.html, Retrieved, December 15, 2012.
[6] http://www.cfr.org/economics/fiscal-cliff/p28757, Retrieved December 15, 2012.
