Just what is this so-called “fiscal cliff” that is regularly injected into discussions as the political season heats up? It’s the debacle scheduled to take place at the end of this year when, barring any intervention by Congress and the president, the terms of the Budget Control Act of 2011 force a set of sharp tax increases and deep budget cuts.
If this were allowed to happen, the sudden blast of fiscal austerity could suck the air out of our fragile economy and send it “over the cliff” into a recession. The Congressional Budget Office estimates the economic shock caused by the higher taxes and lower spending would cut U.S. GDP 4 percent in 2013.
The edge of the cliff will be reached at midnight Dec. 31, 2012, when several temporary tax breaks run out. A short-term payroll tax cut put in place in 2011 is scheduled to end, resulting in a 2-percent tax increase for workers. Also due to expire are the so-called “Bush tax cuts,” a series of changes to the tax code enacted in 2001 and 2003.
Those measures lowered federal income tax rates across the board, lowered tax rates on capital gains and dividend income, and increased the child tax credit. They also eliminated some taxes related to the AMT, personal exemptions and the estate tax. The Tax Policy Center estimates that an average U.S. household faces an annual tax increase of $3,446 if nothing is done to stop this event.
On the spending side, budget cuts agreed to during the 2011 debt-ceiling deal will force automatic reductions in more than 1,000 government programs, with particularly deep cuts in defense and Medicare.
Federal Reserve Chairman Ben Bernanke, who spoke here last Monday at the Economic Club of Indiana and coined the term “fiscal cliff,” has repeatedly implored Congress to act before year-end to prevent the full force of these measures from taking effect.
“I certainly don’t underestimate the challenges that fiscal policymakers face,” Bernanke said in Indianapolis. “They must find ways to put the federal budget on a sustainable path, but not so abruptly as to endanger the economic recovery in the near term.” The full text of Bernanke’s speech is available on the Federal Reserve’s website, www.federalreserve.gov.
Most observers believe Republicans and Democrats will agree to extend the tax cuts and block the spending reductions due to happen at year-end—after all, kicking the can down the road has become a trademark activity for Congress.
However, further procrastination in developing a long-term workable plan to reduce the deficit and national debt will not be well received by the markets.
With Congress preoccupied by the election, a few rational nonpartisan groups have come forward to offer ideas worth debating. Solutions advanced by non-governmental entities include the Simpson Bowles Commission and the independent Taxpayers for Common Sense, which detailed 130 specific deficit-reduction steps, and the Committee for a Responsible Federal Budget, which has looked at cutting deficit spending about $4 trillion over 10 years. Those concepts should be considered.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or email@example.com.