When the US Congress passed the Budget Control Act of 2011, it offered an unwanted final solution to the perennial problem of deficit spending: if Congress could not agree on a plan to reduce the budget, then automatic spending cuts and tax increases would do it for them. The deal was designed to compel an agreement between the parties by threatening stiff measures against their core interests.
U.S. Federal Reserve Chairmen Ben Bernanke warned that the automatic triggers set up by the Act could be a devastating “Fiscal Cliff” for the economy. He coined the term in February during a statement before the House Financial Services Committee, where he described it as “a massive fiscal cliff of large spending cuts and tax increases,” set to trigger at 12am on the morning of January 1, 2013.
These cuts in spending and tax increases are designed to slash the Federal Budget Deficit by a whopping $607 billion. That’s equal to about four percent of U.S. Gross Domestic Product.
Meanwhile, economists warn that if Washington does not act before the deadline is up, the country could face another economic recession for the first half of 2013.
Americans will feel the effect of the Fiscal Cliff almost immediately when the Bush Tax Cuts expire automatically at the end of 2012, raising rates for all income groups, as well as rates on the Capital Gains and Estate Taxes. The income tax rate for top earners will increase from 35% to 40%. This issue has been the most hotly debated in Congress. It also has the most bang-per-buck for deficit reduction — totaling 36% of the $607 billion.
Expiration of the Bush Tax Cuts are good news for Democrats who argue that the wealthiest Americans need to start paying a higher percentage of income tax than the average middle income earner. But Republicans are trying everything in their power to extend the tax cuts, claiming jobs will be lost if the wealthiest business owners must pay more in taxes.
Here’s how the rest of the Fiscal Cliff adds up:
A Payroll Tax increase will also be triggered by the Fiscal Cliff, rising two percent from 4.2% to 6.2%, representing 16% of the total reduction.
The Affordable Care Act Taxes, which take up 3% of the cuts, will increase tax rates on high-income earning households.
Other miscellaneous tax increases, especially the Research and Experimentation Tax, will take up 17% of the total cuts.
The automatic triggers of the Budget Control Act will begin with half the scheduled annual cuts coming directly from the Defense Department Budget. This will be roughly 11% of the $607 billion — which is about $109 billion per year.
The Fiscal Cliff was designed explicitly to punish the interests of both parties if they could not create an effective bi-partisan plan for the budget.
The last time the debt ceiling was reached was in 2011, when Congress increased the debt limit from $14.29 trillion, to what is now $16.4 trillion. The Fiscal Cliff was supposed to cut the debt and avoid another fight over the next debt ceiling limit, which is expected to be reached again in mid 2013.
The main bone of contention is that Republicans refuse to agree to any tax increases.
Senate minority leader Mitch McConnell of Kentucky has made it clear that he will not support eliminating the Bush Tax Cuts: “We need to find a way to deal with sequester not by cutting a penny less, but by intelligently making the decisions that are necessary to keep our promise to reduce the debt by $2.1 trillion and to get our economy back on track.”
A Democratic member of the Supercommitte, Senator Patty Murray of Washington, said recently that the impasse can only be avoided if the Republicans will accept tax increases: “There is one solution to this and everyone knows it. We need to have both revenue and reductions on the page, and so far revenue has not been there because Republicans have refused to.”
Americans will have to deal with sweeping tax increases and spending cuts if the party leaders cannot come up with a plan. With leading Republicans vowing to uphold the ideology of No-New-Taxes, it is difficult to imagine how the Fiscal Cliff can be avoided. But maybe that’s the idea: backed into a corner by their ideological unwillingness to compromise on any tax increases, the Fiscal Cliff offers Republicans a way to save face.