What is the Fiscal Cliff?

Unless Congress acts by January 1, 2013 the federal government will automatically increase taxes and decrease budgetary expenses.  This action will reduce the deficit, but unless it is done thoughtfully it will have potentially negative impacts upon the economy and could push the country back into recession. 

The first component of the Fiscal Cliff is increasing revenue for the Federal Government.  This revenue will come from the expiration of almost every tax reduction since 2001, the largest of which are the Bush-era tax cuts and the two-year temporary Payroll tax cut.  

The Numbers: 

On January 1st, 21.7 million households will see an average tax increase of $3,446. The average federal tax rate, including new taxes for the Affordable Care Act (ACA), would rise by 5% for all Americans.   Additionally, extended unemployment benefits will expire, the marriage penalty tax returns and the child tax credit will be cut in half from $1000 to $500.

As if these tax increases weren’t enough, there’s a second component of the Fiscal Cliff – sequestration.

The tax increases will be coupled with dramatic spending cuts, often referred to as sequestration.  Sequestration will result in over $1 trillion of cuts over nine years or annual cuts of $110 billion to domestic programs including Medicare and national defense.

The problem with sequestration is not necessarily the decrease in government expenditures, but howthe cuts are administered.  Implementation of sequestration is incredibly complex and the rules are often unclear or impractical. These factors, paired with an abrupt timeline for implementation, will not allow for effective management and will likely adversely impact the economy. The Bipartisan Policy Center estimates that the annual reduction in expenses is expected to slow GDP growth by half a percentage point and will cost more than $1 million jobs over a two-year period.  

As our country struggles to emerge from recession, it cannot afford indiscriminate cuts in spending and significant increases in taxes. Moving forward, we need leaders in Congress who are willing to work towards a sustainable bi-partisan budget solution.