Fiscal Cliff Inches Closer Every Day

(eToro Blog) The fiscal cliff that has been talked about in the media on pretty much a daily basis was coined earlier this year by none other than Ben Bernanke, the head of the U.S. Federal Reserve Bank, and is a reference to the dire economic situation that the United States could possible face at the end of the year. Bernanke warned that “a massive fiscal cliff of large spending cuts and tax increases” loomed on January 1st 2013. Here’s what Big Ben was talking about; as of midnight, December 31, 2012, a certain provision of the government’s Budget Control Act of 2011 is likely to go into effect.

The Act is seen as a compromise between the ruling Republican and Democratic parties and which was signed by President Obama last year to put an end to the geopolitical argument over the rising of the public debt ceiling. The Act allowed for the temporary increase of the debt ceiling. More crucially, the Act called for a “Supercommittee,” comprised of members of both parties, to produce legislation which would lower the deficit within the next decade by $1.2 trillion. The Supercommittee’s deadline for such legislation is late November. If the Supercommittee fails in their duties and no other deal is reached before the year’s end, then the spending cuts and tax increases from previous years will revert.

For example, the 2011 payroll tax cuts will revert to a 2% tax hike for the majority of workers. Tax breaks and incentives for businesses as well as changes to the AMT or Alternative Minimum Tax, could result in higher tax payments for a large part of the middle class. Many of these were, in fact, part and parcel of the George W. Bush 2001 tax cuts, which President Obama had extended. Also, the Affordable Health Care Act will require higher income individuals to pay their part through higher income taxes. While taxes go up, spending will go down; including cuts to some 1,000-plus very vital government-run programs like Medicare, not to mention significant cuts in defense spending.

While those spending cuts and tax hikes would, on the face of it, reduce the budget deficit, it would also decimate GDP, with some predictions saying it would be lower by 4% next year alone and the unemployment rate could rise by 1% with an estimated 2 million jobs lost as a result. At best, that could send the economy into a recession, at worst, a depression, as financial markets go into freefall with consumers and businesses both cutting back on spending.

Both parties continue to dicker as to the way forward on this issue, and that dickering will likely continue until after the U.S. Presidential election next month. For now at least, the fiscal cliff continues to loom large. Though the U.S. Congress has the option to retroactively pass the legislation (in the event Congress’s dickering continues beyond the deadline), the potential damage to the markets will assuredly already have been done.

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