The Fiscal Cliff Explained

Have you heard the term “fiscal cliff” tossed around in the news a lot lately? With the election over, the fiscal cliff is getting a lot of attention. That’s why we’re here to give you a clear, condensed definition so you understand it.

In a nutshell, the fiscal cliff refers to a set of steep tax increases and government spending cuts that will take effect January 1, 2013. Historical context for the fiscal cliff dates back to 2001 and 2003 when President Bush implemented tax cuts on personal income. At the end of 2012, these tax cuts will expire, thus increasing personal income tax, which has most Americans (who know about this) up in arms. One school of thought stipulates that the tax cuts should remain for lower to middle-class households and expire for the top 2% of families who make over $250,000 per year.

At the same time this conversation continues about the future of the Bush tax cuts, certain economic stimulus measures that extend unemployment benefits and reduce Social Security payroll taxes are set to expire at the end of the year also. To make matters worse, in an argument over the debt ceiling, Congress and President Obama reached an agreement to reduce non-defense discretionary government spending by $900 billion over the next decade. A committee was tasked with trimming $1.5 trillion off the national debt by the end of 2012, which it was unable to do. This will trigger a $1.2 trillion in automatic, non-defense discretionary spending cuts, which includes a slash to Medicare benefits, at the start of 2013.

As you can see, the fiscal cliff is a perfect storm of spending cuts and taxation hikes that all take effect at the beginning of next year. If Congress does nothing about it, it can be said that billions of dollars will be shaved off the budget deficit. If we look at it a different way, the average American household’s taxes will increase by $2K in 2013. That’s money that would otherwise go toward purchasing goods and services that stimulate the economy. As a result of the effects of the fiscal cliff, the Congressional Budget Office projects that the economy will contract enough in the first half of 2013 that it will slip back into recession.

Nothing will happen overnight, however, and if you’re an employed citizen in the United States, you will see the effects of the tax increases on your paycheck in January. You may not fully feel the burden until tax season. We hope you feel more comfortable with the term “fiscal cliff” now, and if you’re struggling with your own fiscal issues, such as bankruptcy or foreclosure, please consider calling McFarlin LLP. We hope to hear from you.