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Defining the Fiscal Cliff

Posted by Steve Markowitz on October 25, 2012

The term “Fiscal Clift” is being used to give a face to an impending self-inflicted economic crisis that will occur in 2013 should the politicians in Washington not act on the budget.  Beyond general comments that this will lead to increasing taxes and lower government spending, specifics are not often not discussed.  Economist John Mauldin this week posted The Perils of the Fiscal Cliff that succinctly explains the issues.

In 2011 the Republican Congress and President Obama were at odds over the budget.  The President wanted to raise taxes on wealthier Americans to cut the deficit and Congress demanded spending cuts.  Both sides took the disagreement to the brink that could have led to America stop paying on its debt obligations to bondholders.  At the last minute a half-baked compromise was reached and in typical Washington form they kicked the can down the road.  A Congressional committee was set up with members of both parties tasked with coming up with a compromise budget with the caveat that if they did not succeed within a certain time period draconian tax and budget cuts, especially for defense, would automatically occur.

The bipartisan Congressional committee failed to reach agreement.  As Mauldin points out, without Congressional action this will mean a $650 billion hit to the economy next year as follows:

  • $265 billion with the end of the Bush tax cuts, $55 billion will come from Obama’s “millionaires and billionaires” and $210 billion from others.
  • The automatically cuts from debt-ceiling deal that will be about $160 billion, of which $110 billion will come from sequestration, mainly from defense.
  • About $140 billion with the end of the 2% Social Security tax break and extended unemployment benefits.
  • Another $24 billion from a tax increase on wealthier Americans required under Obamacare.
  • The temporary fix of the Minimum Tax expires that will increase taxes by about $105 billion.

While arguments can be made as to whether each action is fair or appropriate, the economic realities are not.  The removing of $650 billion from the US economy while it is so weak will have serious economic consequences.  This equals about a 4% drop in GDP while the economy is only currently growing at about a 2% rate.  The would mean that the economy would contract by about 2%, i.e. a serious recession.

Both political parties own responsibility for the problem.  It has occurred not because the people in Washington are inherently bad.  Instead it results from a corruptive system the rewards politicians (reelects them) based on promises and handouts offered to the electorate, no matter how outrageous.  Resolution of this systemic problem requires only two relatively straight-forward actions: 1) term limits for the Congress and Senate and 2) curtailing Congress from spending annually more than the revenue the Country brings in each year.  It is telling that neither party advocates these actions.  For such common sense Tea Partiers are called radicals.  It does not take a great deal of imagination to determine who promotes that narrative.

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