[News] What Is the 'Fiscal Cliff'?
Posted By: Mark Koba | Senior Editor
| 22 Oct 2012 | 10:53 AM ET
2012 CNBC.com
The 'fiscal cliff' may sound like the name of an exercise retreat on a
mountain top in Southern California, but the reality is not so pretty.
What 'fiscal cliff' actually refers to is the potentially dire economic
situation the U.S. faces at the end of 2012.
The now infamous phrase was coined by Federal Reserve Chairman Ben Bernanke
in February 2012, during one of his required appearances before Congress on
the state of the U.S. economy. He described ... "a massive fiscal cliff of
large spending cuts and tax increases" on Jan. 1, 2013.
Since then, 'fiscal cliff' has taken on legendary status as a harbinger of
economic gloom and doom. (Read More: Why "Rise Above?')
So what does the 'fiscal cliff' trigger for the economy and how bad can it
be? Here's a look.
How does the fiscal cliff come about?
At midnight on Dec. 31, 2012, a major provision of the Budget Control Act of
2011 (BCA) is scheduled to go into effect. This was the deal signed by
President Obama in August 2011 to end the Congressional battle over raising
the government debt ceiling.
The Act was a compromise between Democrats and Republicans on economic
policies while temporarily increasing the debt ceiling — the amount of money
the government could borrow from itself to pay its bills.
The crucial part of the Act provided for a Joint Select Committee of
Congressional Democrats and Republicans — the so called 'Supercommittee '—
to produce bipartisan legislation by late November 2012 that would decrease
the U.S. deficit by $1.2 trillion over the next 10 years.
To do so, the committee agreed to implement by law — if no other deal was
reached before Dec. 31 — massive government spending cuts as well as tax
increases or a return to tax levels from previous years. These are the
elements that make up the 'fiscal cliff.'
What laws from the Budget Control Act will go into place?
Among them are the end of 2011's temporary payroll tax cuts — the result of
which will be a 2 percent tax increase for most workers.
There will also be an end to several tax breaks for businesses, and changes
in the alternative minimum tax (AMT) that could result in more people having
to pay — the income range is currently between $45,000 and $200,000 — and
higher tax payments for those who do.
Several of these existing tax breaks came from the George W. Bush tax cut
bill of 2001, which were extended under President Obama until the end of 2012.
There will also be tax increases for higher income individuals to help pay
for the Affordable Health Care Act (so-called ObamaCare).
At the same time, spending cuts will take place in more than 1,000 government
programs, including cuts in the defense budget as well as social programs
like Medicare, through 2022.
But some programs are exempt from the BCA. Those are Social Security, federal
pensions and veterans' benefits.
What is the impact of the tax increases and budget cuts?
While higher taxes and spending cuts would reduce the U.S. budget deficit by
an estimated $560 billion, the Congressional Budget Office (CBO) predicts
that the policies from the BCA would cut gross domestic product by four
percentage points in 2013. Many analysts say that would likely send the
still-struggling U.S. economy into a recession, if not a depression, as the
financial markets would likely go into a tailspin while businesses and
consumers both cut back on spending.
As a result of the economic slowdown from the stilted GDP growth, the CBO
also predicts unemployment would rise by almost a full percentage point, with
a loss of about two million jobs.
Can anything be done to prevent the 'Fiscal Cliff' from happening?
The major problem has been getting Republicans and Democrats in Congress and
the White House to agree on budgetary policy for the future. Republicans say
they want cuts in government spending to reduce the country's deficit without
raising taxes. For their part, Democrats say they want spending cuts with
certain taxes raised.
There have been calls to extend some or all of the tax cuts and to replace
the massive cutbacks in government spending with more targeted reductions.
Some proposals include repealing the BCA altogether and just keeping what
exists now until another agreement can be reached.
But so far, there is no consensus on what to do, and some analysts say
nothing might happen to avoid the 'fiscal cliff' until the last week in
December.
There is one ace in the hole, so to speak. Even if the BCA deadline comes and
nothing is done, Congress can still act to change laws retroactively if it
chooses.
2012 CNBC.com
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