“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.
The Bush-era tax cut will expire at the end of 2012. Spending cuts are scheduled to be triggered automatically in January 2013 as a result of the failure of the deficit reduction super committee last year.
In dealing with the fiscal cliff, U.S. lawmakers have a choice among three options, none of which are particularly attractive:
In general, 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.
Currently, it appears that a meaningful deal won't be reached until after the December 31 deadline.
If the current laws slated for 2013 went into effect permanently, the impact on the economy would be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the policy would reduce 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.
It's important to keep in mind that the concept of "going over the cliff" is largely a media creation, since even a failure to reach a deal by December 31 doesn't mean that a recession and financial market crash will occur.
Unfortunately, the fiscal cliff isn't the only problem facing the United States right now. At some point in the first quarter, the country will again hit the "debt ceiling" - the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff.
As its name would suggest, the debt limit is simply the maximum amount that the U.S. government can borrow at any given time. Currently, the limit is set at $16.4 trillion. Each year, the government spends more than it takes in, and this gap must be funded with debt, or more specifically, bonds issued by the U.S. Treasury. By law, however, the Treasury can’t issue new debt once the country is at its borrowing limit – and this limit, or ceiling, needs to be agreed to by Congress.
The Bush-era tax cut will expire at the end of 2012. Spending cuts are scheduled to be triggered automatically in January 2013 as a result of the failure of the deficit reduction super committee last year.
In dealing with the fiscal cliff, U.S. lawmakers have a choice among three options, none of which are particularly attractive:
- They can let the current policy scheduled for 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. The plus side: the deficit would fall significantly.
At present the US Economy is growing roughly at 2% per annum. A 4- 6% contraction in GDP caused by the "fiscal cliff" would push the worlds largest economy into a recession.
Coupled with the saggig European economies and a slowdown in China's growth, a recession in US could be really bad for the world. - They can 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 flip side of this, of course, is that the United States' debt will continue to grow.
- They could take a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth.
Worsening of economic situation in the US would have a greater impact on emerging market economies than in the case of situations in the euro area.
Can a Compromise be Reached?
In general, 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.
Currently, it appears that a meaningful deal won't be reached until after the December 31 deadline.
Possible Effects of the Fiscal Cliff
If the current laws slated for 2013 went into effect permanently, the impact on the economy would be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the policy would reduce 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.
It's important to keep in mind that the concept of "going over the cliff" is largely a media creation, since even a failure to reach a deal by December 31 doesn't mean that a recession and financial market crash will occur.
The Next Crisis
Unfortunately, the fiscal cliff isn't the only problem facing the United States right now. At some point in the first quarter, the country will again hit the "debt ceiling" - the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff.
Debt Ceiling
As its name would suggest, the debt limit is simply the maximum amount that the U.S. government can borrow at any given time. Currently, the limit is set at $16.4 trillion. Each year, the government spends more than it takes in, and this gap must be funded with debt, or more specifically, bonds issued by the U.S. Treasury. By law, however, the Treasury can’t issue new debt once the country is at its borrowing limit – and this limit, or ceiling, needs to be agreed to by Congress.
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