What is the fiscal cliff?
The fiscal cliff is the $607 billion economic contraction that will take place on January 1, 2013 as automatic spending cuts, higher tax rates, reduced unemployment benefits, and the end of the payroll tax cut simultaneously kick in.
What could result from these cuts?
Nothing good, it seems. The bipartisan Congressional Budget Office (CBO) says the measures will lead to a recession, potentially causing consumer confidence and investment markets to plummet. While we all agree the U.S. deficit should be reduced, the magnitude of the cuts, coupled with increased 2013 taxes, may force an economic contraction and undermine the budding recovery. Even those experts who are anxious to start cutting the deficit are concerned by the dark clouds looming in the background – Greece, European debt, a possible China slowdown, and the U.S. congressional stalemate. If, on the other hand, Congress postpones some of the spending or tax measures for a year or until the economy is stronger, the economy should continue to rebound in 2013.
How will this latest fiscal drama unfold?
Probably not well. Although there’s a hope that Congress will address these concerns over the summer and provide some comfort and certainty to investors, odds are they will sidestep these problems until after the elections.
“Members of both parties openly admit there’s only the slimmest of prospects for progress before the November elections. Instead, leaders of both parties are jockeying for political position and laying down markers for where each party might stand once serious negotiations to avoid a fiscal disaster get under way, ” writes David Grant of the Christian Science Monitor.
The most likely result is no action before the November elections, then a compromise to postpone implementation of the new measures – perhaps for a year or so – until the new Congress has time for a meaningful debate.
The takeaway: While there is no question the U.S. needs to rationalize spending and overall debt, the combined cuts and tax increases making up the “fiscal cliff” are likely to result in recession. It seems more prudent to phase in tax increases and budget cuts on a more gradual schedule and in the context of a more robust economy. The U.S. economic recovery, and the global economy, are still too fragile for such drastic medicine.