Breakdown: The Fiscal Cliff

So you’ve been hearing about the fiscal cliff on the radio and television for weeks now, right? Apocalypse at the end of the year? But what does it mean, and what’s it about? Read below to find out.

What is it?

The fiscal cliff is the combination of Bush Era tax cuts expiring (taxes increasing) and the sequester going into effect. The sequester is a package of across-the-board spending cuts set to go into effect by the Budget Control Act (BCA) passed in 2011.

How Did it Happen?

In Summer 2011, Congress became embroiled in a debate about raising the debt ceiling. Republicans found the continuous raising of the debt ceiling indicative of a government that was spend-crazy. Democrats argued this was a necessary measure to continue to heal the economy. President Obama eventually agreed to the Budget Control Act, which raised the debt ceiling by $2.1 trillion, but also established a supercommittee that would figure out how to lower the deficit by $1.2 trillion. If the special committee could not come up with a compromise, a wide range of very painful spending cuts would go into affect at the end of 2012. These cuts would go into effect over a nine year period, from 2013 through 2021. The committee ended up failing to be able to compromise and the sequester countdown began.

Back Up. What is the Debt Ceiling?

Ever year, Congress passes a budget. This budget covers discretionary spending, which includes defense, environmental services, veteran services, social services for the poor, etc. We borrow money in order to spend it the things covered in our yearly budget (and then some). Now, the debt ceiling is the legal limit on borrowing by the federal government. If Congress doesn’t increase that limit, the government would not be able to use borrowed funds to pay its bills and the US would have to default on its debt, much like a family that can’t pay the mortgage on their house.

How will it affect me?

The sequester takes an axe to a problem that truly needs a chisel. That is why there is so much pressure to come up with a compromise before the sequester goes into effect. Funding for a lot of things would be slashed under the sequester cuts. Defense spending would but cut dramatically. Social programs would suffer the same. Industries that rely on federal spending would probably have to lay off many workers if the dramatic cuts go into effect. And that’s just the problems of the sequester spending cuts. Last year’s temporary payroll tax cut would expire, and the Alternative Minimum Tax “patch” that keeps it from hurting middle class families too much expires as well.

According to “What is the Fiscal Cliff” by Thomas Kenny, the nonpartisan Congressional Budget Office (CBO) estimates that the combination of higher taxes and extreme spending cuts could reduce gross domestic product (GDP) by four percent, sending us back into recession. The same CBO report estimates unemployment would rise by nearly a percentage point, approximately 200 million jobs.

Ultimately, lowering the debt is not a bad thing. However, too much too soon could throw our economy back into the chaos it is only just starting to climb out of. As you can see, going over the Fiscal Cliff is not ideal.

Will it Happen?

Things have been looking up in recent weeks. Republicans have changed their tone from absolutely refusing to raise taxes to considering the measure if democrats will compromise in other areas. For the moment, we’ll have to wait and see.

Sources:

Klein, Ezra. “Sequester Explained.” Washington Post.

Kenny, Thomas. “What is the Fiscal Cliff?” About.com.

Cha, Ariana. “What is the Debt Ceiling?” Washington Post.

Bipartisan Policy Center. “The Sequester Explained.”