Fiscal Cliff: If You Aren’t Worried, Here’s Why You Should Be
Economists are not known for being alarmists or particularly prone to hyperbole — remember all of those hemming and hawing, obscure and opaque phrases that former Federal Reserve chairman Alan Greenspan was famous for?
So when they all start using a term like “fiscal cliff” to describe the simultaneous onset of big tax increases and spending cuts in the United States scheduled for Jan. 1 — a $720 billion bonanza — it’s hard not to take notice.
Especially when going over the cliff, according to Capital Economics Senior U.S. Economist Paul Dales, could “wipe out the recovery completely.” And Barclays sees a 44 percent probability of this happening.
Indeed, the unknown — the probabilities or possibilities — is the X-factor, as there will likely be no visible effort to avoid the fiscal cliff until after the presidential election. In other words, Congress will have about seven weeks between Election Day and New Year’s in which to steer the economy away from a potentially devastating crisis.
“What investors and companies hate most is uncertainty,” said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co. in New York.
Hence, as the cliff approaches, firms will start to postpone “lumpy,” hard-to-reverse hiring and spending decisions, weakening the economy before we even reach the edge.
“When you are approaching a cliff, in a deep fog of uncertainty, you slow down,” Ethan S. Harris, North American economist for Bank of America Merrill Lynch, wrote in a note. “We expect people to wait until the spring, when the cliff is hopefully resolved, before making important commitments.”
What Is The Fiscal Cliff?
The phrase was coined by Federal Reserve Chairman Ben Bernanke to describe the large spending cuts and tax increases that are scheduled to be automatically enacted at the start of 2013 unless Congress takes action. There are five major elements to the fiscal cliff:
• The expiration of the George W. Bush-era tax cuts and the end of the Alternative Minimum Tax fix. In 2001, 2003 and 2006, Congress passed a series of tax cuts that reduced rates on investment income, estates, gifts and earnings at all levels. Many of these cuts are set to expire on Dec. 31. If this occurs, families would be hit with an average tax increase of $3,000, according to the Tax Policy Center. Meanwhile, Congress has regularly extended the temporary Alternative Minimum Tax “patch” so that more than 20 million relatively middle-income households won’t be subjected to a tax that was originally imposed to ensure that the wealthy paid their fair share.
• The Social Security payroll tax will pop back up to 6.2 percent from 4.2 percent on Dec. 31. Once the payroll tax holiday expires, a median-income household making $51,914 a year will have to pay an additional $1,038 into the system next year — or about $87 a month.
• The expiration of extended unemployment compensation. Support for the jobless — a higher maximum number of weeks the unemployed can collect benefits — is set to expire at the end of this year. That will cut federal spending by about $26 billion between fiscal years 2012 and 2013.
• Big spending cuts. Billions of dollars of federal government spending reductions will go into effect automatically next year, a consequence of Congress’s inability last summer to lower the deficit by at least $1.2 trillion over 10 years. In addition to slashing defense by 10 percent, about 8 percent will automatically be eliminated from non-defense discretionary programs, ranging from education to national parks. The Congressional Budget Office predicts such cuts will reduce federal spending by $65 billion between fiscal years 2012 and 2013.
• The “doc fix.” Reimbursements to doctors who treat Medicare patients will be trimmed significantly, which would lower spending by $11 billion.