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The Fiscal Cliff in a Few Bullet Points

Surely you’ve heard much chatter regarding the looming fiscal cliff. In simple terms, the cliff represents imminent decisions that must be made when the initiatives mandated in the Budget Control Act of 2011 are scheduled to take effect. To be clear, these include:

  • The end of last year’s payroll tax cuts. This will result in a 2% tax increase for workers.
  • The end of certain tax breaks for businesses (many small businesses WILL feel the effect.)
  • Agreed upon automatic spending cuts begin
  • More than 1,000 government programs scaled back (including defense budget and Medicare.)

What does this all mean? Well, it means that our political party leaders have a few unattractive options from which to choose.

  • They can elect to simply allow formerly agreed upon mandates to take effect, which are expected to undermine growth and possibly drive the economy back into recession. (On the plus side, it would go a long way to reduce the deficit – over time, of course, beginning with about $500 Billion immediately.)
  • They can renegotiate terms by canceling some of the tax increases and spending cuts. This would likely add to the deficit and possibly set the Country up for a similar crisis as the one being faced in Europe. (Ask them how they like it.)
  • Or they could try to take middle ground and attempt to approach the budget issues to a limited extent, with a more modest impact on growth.

Can We Get Along?

One of the chief concerns for economists is the impact the fiscal cliff will have on investors, more specifically, how they choose to spend (or not spend) their money. The partisan nature of these discussions certainly does not incite confidence. It seems the back and forth, digging in the proverbial heels, has brought us next to nowhere in delivering pragmatic solutions. Sure, both parties want to avoid the cliff like the plague, yet no one wants to concede ground for fear that any resolution that is successful, particularly if conjured by the opposition, would serve as political Kryptonite in the future.

So what can we expect? Well certainly the stage is set for Congress to take action – at the very last moment possible. What’s worse is that the new Congress won’t be sworn in until January 3rd – a few days too late for the January 31 deadline. Alas, there will probably be some temporary measures put in place to maintain the status quo until a more definitive resolution is instituted. If Congress indeed does take the middle ground, we can expect a short term extension of Bush-era tax cuts, a cancellation of auto-spending cuts as mentioned above. For the time being this could mean the continuation, or at least the appearance of growth without any major economic hit. That being said, the deficit will continue to grow and if no changes are made, problems, big problems, will be sure to follow.

What do You Mean Problems? Like What?

If nothing is done and the formerly agreed upon legislation drops, the foundation of our domestic economy will quake. On the plus side, the deficit will be quickly reduced by hundreds of billions. Simultaneously, the economy will “turn inward” into recession – and possibly worse. And that seems pretty likely if nothing is done. With negative growth also comes unemployment, and all the joy that comes with it. Our barely rebounding  economy is in no position to endure such a mess.

The good news is, we aren’t the only ones who know this. And just because the word “cliff” summons imagery of finality and, well, death. Reality is not so cut and dry. If talks continue and verbal swords are replaced with understanding and logic, changes may be instituted even after the beginning of 2013. I mean, isn’t that the upside of democracy? Ultimately, we can do what we want. Can’t we?

“We the People, in order to form a more perfect union,” are pretty much counting on our Leaders to be smart for a change. There is room for both sides to move and they had better do it – now. For after all, a cliff can be easily negotiated if whittled into simple, measured, steps.

As you read this, President Obama and Speaker of the House John Boehner are currently in private talks, seeking a resolution. Let’s keep our fingers crossed that logic prevails over political posturing.

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