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Breaking Down the Fiscal Cliff

WASHINGTON, D.C. – After much debate and finger pointing the so-called “fiscal cliff” was supposedly avoided by a last minute deal in Washington. In truth, lawmakers on both sides did what they have been doing for quite some time now—kicking the can down the financial doom road and hoping for the best. The deal this past week simply made it certain there will be another fiscal cliff crisis come March.

So what is this cliff that will not go away?

In 2012, the U.S. government expenses were at 153% of tax revenue. According to mainstream Keynesian economic theory (practiced by the U.S. government), during hard economic times it is up to the government to make up for lost demand in the private sector by increasing government spending, thereby pushing the economy out of recession.

But the so-called fiscal cliff entails a huge increase in taxes accompanied by budget cuts that will remove $607 billion from the economy. The end result will be an economic slowdown. The fiscal cliff is not so much a cliff, because the effects of taxes and budget cuts will not be felt immediately, but increasingly as 2013 progresses.

The fiscal cliff exists because the U.S. government must cut down the deficit spending. Enabling the fiscal cliff will crack $607 billion off from the U.S .government budget deficit, erasing approximately half the deficit. Politicians want to avoid the fiscal cliff because it will put the economy in recession, and they don’t want to cut funding to their favorite government spending.

If the fiscal cliff is “avoided,” then the issue is simply pushed down the road, for another day.
Resolving the fiscal cliff will be problematic, due to the strong difference in opinion between Republicans and Democrats. Since there is no way around this cliff, it will eventually turn into finger pointing from one side or the other.

A breakdown of the fiscal cliff budget looks like this:

  • $221B – Expiration of tax cuts and the subsequent growth in the AMT: $221B (36.41%)
  • $105B – Other changes (mostly revenue, primarily reflecting economic growth)
  • $95B – Expiration of 2% FICA tax cut $95B (15.65%)
  • $26B – Expiration of unemployment insurance (4.28%)
  • $18B – Obamacare taxes or Affordable Care Act taxes: $18B (3.97%)
  • $11B – Reduction in Medicare payment for doctors: $11B (1.81%)

Beginning in 2013, Americans will pay more in taxes. Bush era tax cuts, the FICA 2% payroll tax cuts and other tax provisions will expire. Obamacare taxes will show up. Altogether this amounts to an increase of $400 Billion in new taxes.

No one can wrap their mind around a billion dollars much less $400 billion. To make an attempt at understanding how much money we are talking about, imagine a truck that can hold $2 billion. Now imagine enough trucks to hold $400 billion. That would be a line of trucks almost three miles long.

In spite of this large tax increase, the fiscal cliff will cut $207 billion out of government budget. $65 Billion in cuts will come from “Automatic Sequestration,” a fancy name for automatic spending cuts that are the consequence of the Super Committee failing to come up with a plan to cut $1.5 trillion over 10 years.

Sequestration cuts will be divided equally between defense and non-defense spending. This includes $26 billion in cuts that will come from the unemployment benefit extension that is expiring, $11 billion from reduction in Medicare payment rates, and $105 billion from other spending reductions.

Because the country is so deeply divided, as was evidenced in the last election, it is highly unlikely a consensus opinion can be reached as to a sensible way to avoid this budgetary crisis. No matter what either side says, make no mistake about it, this crisis is real and not contrived. You can only kick the can down the road so many times before it spills over and its contents are lost.

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