UNDERSTANDING THE U.S. FISCAL CLIFF

"Fiscal cliff" is the popular short term used to decsribe the situation the U.S. will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.

Among the laws set to change at midnight on December 31, 2012 are the end of last year's temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, and the beginning of taxes related to President Obama's health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling of 2011 will begin to go into effect. According to Barron's, over 1,000 government programs- including the defense budget are in line for deep, automatic cuts.

Although both parties want to avoid the fiscal cliff, compromise is seen as difficult to achieve, particularly in an election year. The most likely result is that the problem will linger until after the election, and there is a strong possibility that Congress won't act until the eleventh hour. The most likely result is another set of stop-gap measures that would delay a more permanent policy change until 2013 or later. The election will almost certainly have an impact on the direction of future policy, particularly if one party earns a decisive victory.

If the current laws slated for 2013 go into effect, the impact on the U.S. economy could be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estaimated $ 560 billion, it is estimated that the policies set to go into effect would cut gross domestic product (GDP) by four percentage points in 2013, sending the U.S. economy into recession (i.e. negative growth). At the same time, unemployment would rise by almost a full percentage point, with a loss about two million jobs. Admittedly, the U.S.economy is not in a position to avoid this type of shock. The cost of indecision is likely to have an effect on the economy before 2013 even begins.