What Exactly is the "Fiscal Cliff" and Why Should I Care?
The "Fiscal Cliff" you have been hearing about is the result of two major events that, if not delayed or otherwise modified by the US Congress, will occur in January 2013:
US federal government spending cuts - these will happen automatically, the result of the 2011 debt ceiling deal
Expiration of 2001-2003 tax cuts enacted during the Bush administration - in order to pass these tax cuts, Congress could not make them permanent (they had to expire in 10 years)
If nothing is done, the combination of the reduced government spending coupled with higher taxes will result in a drag on the economy that could be sufficient to put the economy back into recession (that is, if it isn't already in a recession). The Congressional Budget Office estimates the reduction in Gross Domestic Product (GDP) would be 4%! A Wall St. Journal article from May 16, 2012 estimates the following impact in dollar terms: “In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts; $125 million from the expiration of the Obama payroll-tax holiday; $40 million from the expiration of emergency unemployment benefits; and $98 billion from Budget Control Act spending cuts. In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that, according to the J.P. Morgan report.”
The Obama administration has said it is seeking tax increases for individuals who make more than $200,000/year and couples who make more than $250,000/year - i.e., the "rich." If you live on one of the coasts making that kind of money and have a few kids, a couple of cars and a mortgage, you are hardly rich.
What is most likely to occur is that the Bush tax cuts will be temporarily extended and the spending cuts will be temporarily delayed - perhaps for a year or so, although current partisan political rhetoric is indicating "no deal" will be possible. The flip side of this, however, is that the US government debt continues to grow rapidly and will continue to grow until spending is curtailed and/or taxes are raised. By 2015, the gross public debt is projected to exceed $20 Trillion (already over $16 Trillion today)!
In the not too distant past, the top Federal tax rate was over 90%, as noted in the chart below. Do you think that eventually, taxes will return to those levels in order to service the growing mountain of government debt? Seems likely.
US Federal Income Tax Rate for Top Income Bracket 1929 - 2011 (Photo credit: Cory M. Grenier)
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