Imagine your finances are in shambles. You’re drowning in credit card debt and not making nearly enough money. So you cut your discretionary spending and get a second job to generate some more income. Most would applaud the responsible steps you are taking to fix your finances. If you are the government, however, we call it the ‘fiscal cliff.’
The term fiscal cliff refers to a series of tax increases and spending cuts that under current law will go into effect on January 1, 2013. Given the Thelma and Louise imagery the name conjures, you might think the upcoming changes would at least solve our country’s fiscal crisis. If only that were true. Even if the law remains unchanged, our deficit next year will still exceed $600 billion, which is higher than any deficit under the Bush administration.
Anatomy of the Fiscal Cliff
Here are the main components of the Fiscal Cliff to take effect next year:
- Expiration of the Bush tax cuts for everybody, not just those making more than $200,000;
- Spending cuts, called sequestration, to most discretionary programs, including defense;
- Reversion of the Alternative Minimum Tax thresholds to their 2000 tax year levels;
- Limits on Medicare spending increases;
- Expiration of the 2% Social Security payroll tax cut;
- Expiration of federal unemployment benefits; and
- New taxes imposed by Obamacare.
The impact of these changes is significant, as reflected in the following table summarizing projections made by the Congressional Budget Office:
No Fiscal Cliff
|FY 2013 Deficit||$641 billion||$1.037 trillion|
|FY 2013 Projected Economic Growth||−0.5% of GDP||1.7% of GDP|
|Unemployment Rate in 2013||9.1%||8.0%|
|Public Debt in 2022||58% of GDP||90% of GDP|
As you can see, even if we go over the Fiscal Cliff, our annual deficits will still be enormous. And that gives you an idea of just how bad things are. Here’s a chart that provides a different perspective on the same data:
Source: USA Today
And if you are wondering just how all these items add up, more than 50% of the deficit reduction would come from just two sources–expiration of the Bush tax cuts and expiration of the 2% FICA payroll tax cut. The spending cuts are just a modest 10% of the deficit reduction.
Should We Fear the Fiscal Cliff?
As noted above, the CBO projects that if we go over the cliff, unemployment will rise above 9% and we’ll go into a recession. Given what we’ve been through over the last few years, the thought of another recession is a bit overwhelming. But in the long term, it may be the best option.
Some short term pain now may help us avoid much more difficult decisions down the road. And the irony is that a do-nothing government going over the fiscal cliff may be the only way to get anything done!
What do you think–Should we do a Thelma and Louise over the fiscal cliff on January 1?
Published or updated January 1, 2013.