What is Fiscal Cliff?

We come across the term “cliff” in Physical Geography while reading about various landforms. A cliff is a significant vertical, or near vertical, rock exposure, which is formed by processes of erosion and weathering. Tall cliffs around the worlds are ideal locations for those who wish to end their lives! In recent times, the term has been widely discussed with reference to some fiscal events happening in United States. Here is a brief story:

Expiring Bush Tax Cuts

With the Financial crisis of 2008-09, America had turned itself into the sick sample of international capitalism. The crisis was extraordinary and required extraordinary efforts to tackle. Several measures were taken to save the Americans’ pockets. During the times of George W. Bush, three legislations were passed to relieve help the US tax payers. These laws were as follows:

• Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)
• Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)
• Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

These laws are collectively called Bush Tax Cuts. The acts had a sunset clause which could lead them to expire by 2010, but nevertheless they were extended by Obama Administration for additional two years. Now the time has come when these Tax cuts are about to expire.

AMT Holiday Over

An Alternative Minimum Tax was designed in America to prevent millions of middle-class income earners from paying the tax , but to make sure that the nation’s wealthiest people pay at least some taxes. The Obama administration had made some exemption to the Alternative Minimum Tax, initially which were extended every year for last 2 years. These exemptions are now about to end.

The public Spending to cut automatically

To handle the Financial Crisis of the last decade, United States of America and some of the European countries had greatly increased their already large public debt loads by borrowing more money to fund financial losses, bailouts, tax cuts and fiscal stimulus. A major part of tax cuts was offset by the Borrowings. The borrowing in United States was on a huge scale. In 2011, the government was running an annual deficit of about $1.4 trillion, which corresponds to about 9.5 percent of its GDP. During 2011, US Government borrowed close to 40 cents for every $1 it spends. Such a massive annual deficits have led to the swollen U.S. federal gross debt to about $14.3 trillion. The $14.3 trillion was the legal borrowing limit fixed in US, known as Debt Ceiling. In August 2011, the US Congress passed the Budget Control Act of 2011, wherein it was agreed to create a Super Committee (Of Congress) which shall bring in a legislation that would reduce the deficit by $1.2 trillion over ten years. It was also provided in the law that if this super committee does not come up with such legislation, there would be automatic across-the-board cuts called “sequestrations” that would commence from January 2013. The Super Committee could not do what it was expected to do, and so the time for across the board cuts called sequestrants is to begin from January 2013.

New Taxes on American’s Pocket

At the same time, the Affordable Care Act or the so called Obamacare imposed new taxes on families making more than $250,000 a year also starts materializing from the next month onwards.

So, in all, the following are supposed to make a bombshell on US economy in the beginning of 2013:

• Bush Tax cuts will expire
  
• There would be across-the-board spending cuts (“sequestration”)
  
• The Alternative Minimum Tax returns
  
• The 2% Social Security payroll tax cut ends
  
• The Government provided federal unemployment benefits also expire
  
• New taxes would start as per the so called Obamacare.
  

Some provisions would increase taxes while others would reduce spending. The collective impact would be a sharp reduction in the Budget deficit of the country. This is what the government wanted to achieve but the speed with which it is going to happen would put so much strain on US Economy that the experts say that it will trigger a new recession in the US economy. This sharp decrease in the deficit in such a short period of time is known as the fiscal cliff.

What is going on?

The US president and congress have two choices. The first choice is that they do nothing, which could substantially reduce budget deficits but risk plunging a tenuous economy back into recession. The other alternative is to pass a new legislation to extend tax cuts and/or postpone the spending cuts. This would momentarily lessen recession risk but continue to add to the ballooning national debt.