Fiscal Cliff: Answers to Questions You're Embarrassed to Ask

Robin Renford
Robin Renford
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The person on the street is suddenly bombarded with this huge term, “fiscal cliff”.  He throws a lot of simplistic, but valid, questions; so we throw back these simple answers and hope he gets a clearer picture and continues with his quiet life.

Why is it a cliff?

It’s called a cliff because it is the high point when taxes increase and spending cuts will occur in January to pay a portion of the national debt, and, from there, a sudden dip (like in a cliff) towards a probable recession caused by too much money (around $607 billion) taken away too quickly from the economy. It’s like slashing your paycheck in half to pay for an outstanding debt, but in the process, you create another problem: how to survive with half a paycheck. The cliff, others say, is not really a cliff; rather, a series of tax and spending cuts spaced over the coming months, resembling more of a hill’s gradual slope.

Isn’t it good to cut our debt?

Because taking away $607 billion from the economy in so short a time creates more problems. Higher taxes mean lower income and consumer purchases, and government spending cuts, particularly in defense and social services, mean reduced investments for many suppliers and their derivative businesses and more sick people out in the streets. The Congressional Budget Office (CBO) says these factors will spill over to job cuts, inflation and business closures, a notion shared by many CEOs. In fact, CBO calculates that factoring in these negative economic spillovers, we will only cut the deficit by $560 billion by end of 2013 instead of $607 billion. That’s $47 billion gone to waste. The alternative is to find a balance between paying off the national debt while allowing the economy to keep humming and growing.

Why would Congress put the nation in a peril?

It’s more like inaction than an action by Congress that created the cliff. Democrats and Republicans failed to meet a consensus on how to pull down our deficit during Obama’s first term. What they did, as James Surowiecki wittily pointed out in a New Yorker opinion, was to agree to agree, that if both parties cannot come to terms, they will penalize each other with a situation that is so ugly they will have to answer to their constituents. Nobody wants that, so the idea is everybody will find a way to avoid the fiscal cliff. It is also a political maneuver for both parties, dilly-dallying for the elections to feel the public’s pulse. The election has given the Democrats political capital and now they intend to negotiate from a point of strength. The Congress, to our collective relief, has had succeeded in passing deadline-critical laws in the past. You’re not alone if sometimes you just have this nagging feel you’re a carrot at the end of a string dangled by your politicians.

We’re okay before the Bush tax cuts, we should be fine now that these are gone, right?

The details notwithstanding, we wouldn’t need the Bush tax cuts if we were doing okay back then, right? Many pundits agree that from Clinton’s time, we have been in a downward slope with small plateau stopovers along the way that appeared like the good old times of the eighties. But they were more like the calm before the storm or the credit before payment. In reality, a crisis was looming and nobody told us until the subprime market slapped us in the face really hard. More than ever, every penny counts now, whether to pay for your expenses or the country’s.

Everyone will pay additional tax so it’s fair

Tax increases will be across the board, but the middle class—high-wage earners and small business owners—will be hit hardest. Collectively, they will have to shell out about $2,000 more from their salaries, while the really rich can circumvent fundamental flaws in our tax system with their teams of lawyers and accountants and offshore resources. The lower wage earners will also feel the impact of weaker social services and possibly job loss, and when more middle class joining the ranks, the social welfare will be strained. Obama plans to tax more of the rich in this mindset.

What is likely to happen?

The Bush-era tax breaks will be extended, with a couple of breaks being forfeited, perhaps on capital gains, dividends and estate. These are known territories of the moneyed, and Obama is bent to tax them more in his second term.  Additional tax revenues may come from this group, albeit at a reduced rate to appease the Republicans. As a trade-off, maybe a reduction, not elimination, in social services is in the offing, too; but it is doubtful health care will be touched, one of Obama’s solid platforms.

CONCLUSION

“We are a nation of individualists who believe that they can survive anything with the right tools and talent.” These are the words not by a celebrated statesman, decorated politician or successful businessman, but by Max Brooks, author of Zombie Wars, a novel where the world is overrun by the undead.  Everybody is affected, so everybody must chip in a sacrifice to work things out until we slay the zombie that is our deficit.

What do you think will happen?

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Robin Renford

Robin talks about a wide range of financial topics, from macro-economics to personal finance, and investment portfolios to proprietorship. He focuses on providing financial advice to his readers as part of the FinancesOnline team. He is also working on a book about wealth management for the average American, using his more than a decade of experience and exposure to the business sector as inspiration.

Category: Financial News

2 Comments »

  • Graham Henderson says:

    The European “austerity” model encompases not only increased taxes but also cuts in spending. However, it looks like the current administration looks up to European solutions, so maybe we can see where it works better. I really doubt it will work better in the US, mainly because it doesn’t work that well in Europe after all.

  • Morgan Morrison says:

    Going back to tax rates from Clinton’s presidency would most likely be a step backwards. On the other hand, what isn’t these days? I believe that the burden of Obamacare is going to have a disruptive influence at least as negative as that of the fiscal cliff. If we also consider how this administration makes energy costs skyrocket then it looks like there is no way out regardless of Obama’s and Boehner’s ideas.

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