Fiscal Cliff 2013: Taxmageddon Could Cause Another Deep Recession in America

As President Obama settles down following his election victory on Tuesday, the American people will be looking to him to fulfil his election promises and continue to drive America forward towards prosperity. One issue that the president must address soon is the coming “fiscal cliff” that America is currently standing at. Today, Obama will today use a White House appearance to set the tone for the upcoming talks in Congress on the issue. But what is the “fiscal cliff”? What impact will it have on the economy if the U.S. was to fall off it? And, what is actually likely to happen? 

The issue has been on the horizon for almost two years and the December 31 deadline is almost here, the date when the terms of the Budget Control Act of 2011 are set to come into effect. The term “fiscal cliff” refers to the dramatic changes that would occur as a result of the laws and the immediate consequences that they would have on the economy. Many commentators feel that the U.S. economy is not stable enough to avoid the shock and as we move closer to 2013, the U.S. is moving closer towards the edge.

Now that election season is over, it is hoped that Congress will at last be able to focus on the problem and actively find a solution – even if that it is likely to come at the last possible moment. What is key however is that the politicians can no longer put it off.

Set to change are a mixture of laws which will affect the ordinary American, including the end to last year’s temporary payroll tax cuts, the end to certain tax breaks for businesses, and the beginning of taxes relating to Obama’s health care law.

While local governments and individual states have so far been the hardest hit by the spending cuts, it is now the turn of the federal government with around $108 billion expected in cuts to over a thousand government programmes ranging from defense to Medicare.

If the current laws go into effect, the impact on the economy could be dramatic.

What impact will these changes have if no solution is reached by Congress?

The term “cliff” indicates an immediate disaster at the beginning of 2013; in fact, even if no solution is found, the impact of the changes is only likely to be gradual at first. That is not to say that the changes wouldn’t have a potentially destructive impact over the course of next year.

Failure to avoid the cliff could plunge the U.S. economy back into recession and disrupt the global economy’s still fragile recovery. This would perhaps put the U.S. in diplomatic hot water if they were responsible for triggering another recessionary wave.

The combination of higher taxes and spending cuts could reduce the deficit by an estimated $503 billion, which sounds too good to be true. That’s because it is. According to a new report, the Congressional Budget Office (CBO) has predicted that if the policies go into effect, the GDP would be cut by 4 percentage points in 2013, which would result in the economy spiralling into recession.

Unemployment levels would rise between 1 and 2 percentage points to a maximum of 10%, resulting in up to an additional 2.8 million Americans out of work. The Financial Times has for instance predicted that letting temporary tax cuts and the unemployment benefits expire will reduce 2013 output by 0.7 per cent which would mean the loss of approximately 800,000 jobs.

What is likely to happen?

In the short term, households and businesses may change their spending habits as Congress remains indecisive. It has been reported that businesses were holding back investment and hiring as a result of worries about the fiscal cliff. The markets may also remain in a state of cautiousness, which Obama should be very vigilant about following the tumbling of the U.S. stock markets on Wednesday.

The most likely course Congress will take is to pass another set of stop-gap measures without making any policy changes until 2013 or later. This won’t necessarily have any major impact, and will allow more time to consider the best possible solution for the U.S. economy and the American people.

The CBO estimates that if Congress takes the middle ground by cancelling the automatic spending cuts and extending some tax cuts, the result in the short term would be some modest growth. This is possibly the best outcome that can be expected. This will still leave a very large budget deficit to deal with though.

If Obama is to move into his second term seamlessly and from a position of strength, he should do all he can to steer and encourage Congress to find a solution.