Asked & Answered: What's the Fiscal Cliff?

Nelson from Newton, MA:

What exactly is the so called “Fiscal Cliff” and what are the impacts if we go over it?

Friedenthal Financial:

The Fiscal Cliff is really a combination of tax increases and budget cuts all set to become effective simultaneously on Jan 1, 2013, if no other legislation is put in place prior.  In the summer of 2011, amidst much debate over the US debt ceiling and ever growing government budget deficit, Congress put in place a bit of a political time-bomb.   That is to say that legislation was put in place to buy time, acknowledging about 18 months to come up with a real solution.  The problem, of course, is that time is now running out.

While nearly everyone from both sides of the political aisle seems to believe that “something” needs to be done as our deficit and national debt soar, there are quite divergent views on which budget items should be cut and who should bear the biggest tax increases.

The Congressional Budget Office projects that the annual budget deficit would be reduced by roughly 50% for 2013 if all slated changes go into effect.  It is widely believed that having such drastic and sudden measures (note in other countries we would just call it “austerity”) would cause unemployment to rise and GDP to slow, putting us squarely back into a recession.  Thus, very few believe that we should live with the currently slated changes for 2013.  Political stubbornness calls to question the probability of a mutually agreeable solution prior to year-end.  Hence, the concern about the looming “cliff”.

Some highlights of the tax hikes slated for 2013 are the expiration of the so called “Bush” tax cuts, the exemption from the Alternative Minimum Tax (AMT) and the expiration of the Social Security (FICA) payroll tax reduction.  In addition, the Affordable Care Act (aka “Obamacare”) imposes new taxes on families in the $250k+ income bracket (or individuals $200k+).  The Budget Cuts are slated to be distributed across the board between domestic spending and defense, impacting 1,000+ government programs.

We think that even if a long term solution isn’t reached in the next 6 weeks, that some type of stop-gap will be put in place by then.  The proverbial “can” will likely be kicked at least partially down the road.  While this may not be ideal, having a more gradually implemented solution is likely better than the Draconian alternatives.

We hope that helps and provides fodder for discussion. Please let us know if we can be of further service!

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