All you wanted to know about Fiscal Cliff

Last Updated: Sat, Nov 10, 2012 04:11 hrs

The term “Fiscal Cliff” has become the darling of economists and financial analysts around the globe in the last few weeks. It is difficult to hear any discussion or read any column without a reference to the F-phrase. It is the latest in a series of terms that have been made famous by Federal Reserve Chairman Ben Bernanke. FC’s older brothers include ‘Green Shoots’, ‘Operation Twist’, ‘QE (Quantitative Easing)’, etc. Abhishek Vasudev demystifies the latest verbal time-bomb from Uncle Ben’s arsenal:

What is fiscal cliff?
Fiscal cliff refers to a range of expiring tax cuts and a number of planned spending hikes. These include the Bush tax cuts and the indexation of the alternative minimum tax (AMT) for inflation. Fiscal cliff will come in place on January 1, 2013 which would include a combination of spending cuts and tax increases.

Who used the term first and when?
In February 2012, Ben Bernanke, chairman of the US Federal Reserve, used the term while describing the challenges facing the US and global economy.

What are the reasons? Why did this happen?
The tax cuts during the regime of George Bush in 2001 and 2003 reduced individual income taxes. They were extended in 2010 to support the economic recovery. This extension is set to expire on December 31, 2012. Another large part of the cliff is the two percentage-point payroll tax break for calendar years 2011 and 2012 that was part of the government’s efforts to strengthen the recovery after the recession. On the spending front, it consists of a range of other changes in revenues and spending that add up to $160 billion. The most conspicuous are the $18 billion taxes for Obamacare, the expiration of the emergency unemployment benefits ($26 billion) and the $11 billion reduction in Medicare’s payment rates for physicians. That makes the total fiscal cliff $607 billion.

What are the implications?
This would mean higher taxes and reduced spending that would result in reducing the budget deficit for fiscal year 2013 to four per cent of gross domestic product, down from 7.3 per cent in 2012, a substantial improvement in the federal debt trajectory. However, it would also send a massive negative fiscal impulse through the economy, as businesses and households are hit by higher taxes and a decline in government spending on goods and services. The full fiscal cliff of $607 billion would lead to a recession in the first half of 2013, and shrink the economy during 2013 by 0.5 per cent (measured from 2012Q4 to 2013Q4), according to estimates by the Congressional Budget Office (CBO).

Will Obama climb over the cliff?
In the victory speech, President Obama listed “reducing our deficit and reforming our tax code” as among his top priorities. He is expected to initiate a new round of talks with leaders of Congress. The goal would be a “grand bargain” combining higher taxes and money-saving changes to federal benefit programs. However, congressional Republicans are against the increase in taxes and reduction in spending, and convincing them would be a tough task for the President.

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