11 December 2012
The Fiscal Cliff
Can the United States handle another recession now or should we delay it until later? This is one of the main questions that President Barak Obama and Congress have to answer by December 31, 2012 in relation to what is now known as the “Fiscal Cliff.” While to some the decision may seem easy, in reality, nearly 500 billion dollars of public debt hangs in the balance. What is being regarded as one of the most important economic pronouncements of all time, the actions and strategies that Congress will implement will set the economic tide for the next 50 years. Economists have only recently started to dissect and forecast different outcomes reading the Fiscal Cliff. The first being called the “Baseline Projection” which forecasts what would happen if the Bush tax cuts were allowed to expire and spending cuts were implemented. The second is called the “Alternate Fiscal Scenario” involves extending the Bush tax cuts, repealing the automatic spending cuts, restricting the reach of the AMT and keeping Medicare reimbursement rates at the current level. In this paper, I will discuss and explain what the Fiscal Cliff is comprised of and the two possible economic scenarios that the United States will face.
In order to fully understand the possible scenarios that may unfold involving the Fiscal Cliff, one must first be able to comprehend exactly what the Fiscal Cliff consists of. The fiscal cliff is a term used to refer to the economic effects that could result in tax increases, spending cuts and a corresponding reduction in the US budget deficit beginning in 2013 if existing laws are not changed by the end of 2012. With the sharp increase in money supply, the United States is expected to decrease its deficit by nearly half in just the first few days of the New Year. This sharp falloff in the deficit is where the term “Fiscal Cliff” comes from. It was first used to describe this current situation in late of February 2012 when Ben Bernanke addressed the House Financial Services Committee. He was quoted saying “a massive fiscal cliff of large spending cuts and tax increases” would take place on the first of January
The two main components that consist of the Fiscal Cliff are the Bush tax cuts and planned spending cuts under the Budget Control Act of 2011. With the public debt ceiling being a major concern at the time, this law was enacted as a compromise. There are a few major programs that are exempted from the spending cuts including Social Security and Medicaid. Another part of the Cliff is the impact it will have on the AMT. The Alternative Minimum Tax is an income tax imposed by the United States federal government on individuals, corporations, estates, and trusts. AMT is imposed at a nearly flat rate on an adjusted amount of taxable income above a certain threshold.
With the new year approaching, the thought of the Fiscal Cliff is looming in the back of everyone’s minds. The Congressional Budget Office has compiled two scenarios that they feel outlines what will happen to the economy over the next 30 per the outcome of the Fiscal Cliff debate. The first of the two scenarios is called the baseline scenario. This is the path were spending cuts are implemented and the Bush tax cuts are allowed to expire. This will lead to significantly higher tax revenue for the government. Pairing that with the reduced spending will lead to a lower deficit, debt and interest for an estimated 10 years. Reducing the deficit in such a significant way is a huge factoring when considering whether or not to let the tax cuts expire. The CBO predicts that future deficits would be reduced from their current levels of 8.5% GDP to 1.2% by 2021. Concurrently, revenues would rise from the current average of 18% GDP to near 24% of GDP.
One of the most concerning predictions that was released with this report was the amount of the deficit