Falling Off the Cliff

What is the fiscal cliff?

“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.

Among the laws set to change at midnight on December 31, 2012, are the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would take a larger bite, the end of the tax cuts from 2001-2003, and the beginning of taxes related to President Obama’s health care law.

At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. According to Barron's, over 1,000 government programs - including the defense budget and Medicare are in line for "deep, automatic cuts."

In dealing with the fiscal cliff, U.S. lawmakers have a choice among three options, none of which are particularly attractive:

1. 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 – go into effect. The plus side: the deficit, as a percentage of GDP, would be cut in half.
2. 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.
3. 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.

What is the effect on the economy?

According to the Congressional Budget Office, a non-partisan organization, if there is no other agreement and the fiscal cliff is crossed on Jan. 2, the United States could fall back into a recession in 2013.

That will have a tremendous negative impact on the global economy as Europe is in a recession and economic growth is slowing in China and India.

Based on the 320-point drop in the Dow Jones Industrial Average the day after President Obama's re-election, Wall Street is not bullish about the future of the economy.

What are the barriers?

Speaker John Boehner delivered remarks and took questions from press on Friday, ahead of President Barack Obama‘s scheduled remarks on the economy. Noting the need to tackle the “fiscal cliff” and reach bipartisan solutions, Boehner said “this is an opportunity for the president to lead.”

“This is his moment to work on a solution that can pass both chambers,” Boehner said, also adding that he add a “cordial” meeting with the president earlier this week.

Boehner expressed hope that “2013 is finally the year” the government can agree on a grand bargain on spending and debt. “When the President and I have been able to come to an agreement,” he said, “there’s been no problem getting it passed in House.”

Regarding a tax deal specifically, the Speaker argued that “raising tax rates will slow down our ability to create the jobs that everyone says they want.” Reinforcing an often-cited Republican argument, Boehner said the problem with raising taxes on the wealthiest “is that more than half are small business owners.”