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What Exactly is the “Fiscal Cliff”?

The term “fiscal cliff,” coined by Federal Reserve Chairman Ben Bernanke and sensationalized by the media, is somewhat misleading. Some policy analysts have defined this issue as the “fiscal hill or slope,” emphasizing the resulting economic environment will occur gradually, opposed to an abrupt financial disaster. Regardless of how it’s classified, most agree any inaction to resolve this could lead to another recession.

The United States arrived at the “fiscal cliff” due to four specific tax measures that expired at the end of 2012:

  1. The Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (known as the Bush Tax Cuts) – these cuts lowered both individual and investment income tax rates while expanding existing tax credits.
  2. The American Recovery and Reinvestment Act of 2009 (known as the stimulus plan) – this stimulus package expanded programs like the American Opportunity tax credit, which helps students pay for college.
  3. The Payroll Tax Holiday – this reduced the payroll tax rate from 6.2% to 4.2% on employees.
  4. The Alternative Minimum Tax – this tax was originally intended as a standard tax for the wealthy, however it has not been adjusted for inflation and would include many middle-class families

If these measures were to continue into the coming year, they would cost more than $440 billion. However, in addition to taxes, the “fiscal cliff” also includes spending cuts, such as:

The Budget Sequestration 

  • A group of automatically-triggered spending cuts from the Budget Control Act of 2011 (known as the debt ceiling). These cuts are both in defense and non-defense spending, including a 2% cut in Medicare payments.

The Debt Ceiling 

  • The next debt ceiling increase is expected in February 2013—estimated to be anywhere between $700 billion and $1.2 trillion to cover spending for 2013.

Doc Fix 

  • The policy reverses temporarily cuts as a deficit reduction measure. The cuts known as the Sustainable Growth Rate requires that growth in provider payments not exceed growth in the US GDP. If the doc fix is not extended, physician payments would drop by more than 25%.

Unemployment insurance 

  • Unemployment insurance has been continuously expanded and approved following the 2008 recession.

Both parties have spent considerable political capital in these negotiations but have fundamental differences in what tactics are needed to combat these financial issues. The basic issue is firm: the government will either need to cut spending, increase taxes or find a compromise. On January 1, the Senate and subsequently the House passed the American Taxpayer Relief Act of 2012, which was signed by President Obama on January 2. The law will, among other things:

  • Gradually suspend tax credits for individual incomes over $250,000 and $300,000 for couples
  • Amend the alternative minimum tax so as not to include middle class families
  • Delay the budget sequestration for two months
  • Extend the doc fix and unemployment insurance for one year

The law is expected to generate well over $500 billion in tax revenue over the next decade. While this law is less than 24 hours old at press time, it has already garnered both acclaim and criticism. The coming weeks, months and even years will reveal how grave the “fiscal cliff" was and if the response was effective.

Read more from Advocacy Brief 

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