The Fiscal Cliff

If Fed Reserve Bank Chairman Ben Bernanke had a nickel for every utterance and printing of the catch phrase he coined way back when, the words “fiscal cliff” would be making him a millionaire several times over… of course given the depreciated value of the U.S. Dollar that’s not worth quite as much as it used to be. Be that as it may, the U.S. fiscal cliff is looming and within a few short days the U.S. government will be at its precipice.

All work and no play

As the last day of the year approaches, you’d typically find members of the U.S. Congress home in their respective constituencies spending quality time with their families and friends. Instead, they’re on standby, as is President Obama who cut his Hawaiian holiday vacation short, so that a deal can hopefully be reached and a crisis averted.

If the U.S. government fails to stop the plummet over the cliff, several bad things will happen, automatically. First, the expiration of certain federal tax breaks will mean about $536 billion worth of tax increases will come into effect for nearly every American taxpayer; one bipartisan survey estimates that taxes could increase by as much as $2,400 for families which earn between $50,000 and $75,000.

Second, another $110 billion worth of spending cuts will affect the federal government’s various programs, most specifically the military with the Pentagon seeing their annual budget slashed some 9%. Only a very few government programs, like Social Security benefits and programs for veterans and the poor, will be exempt from the spending cuts. The government as a result would be forced to significantly curtail government contracts and could lay off thousands of government workers; one estimate by the Congressional Budget Office suggests that eventually some 3.4 million jobs (governmental as well as private sector) will be lost in total.

Potential turmoil may await

Analysts and economists predict that a fall over the fiscal cliff and the “double whammy” which will ensue will throw the U.S. economy into recession, leading to a hike in the already too high for comfort unemployment rate and turmoil in the financial markets. At the close of last week’s trading, global equity prices tumbled, and Wall Street yesterday posted its third consecutive loss. But Europe’s equity markets are all cautiously higher today in the hope that the U.S. government can pull out a miracle.

Can they? Or is it all doom and gloom? The U.S. economy will take some time to react to the tax increases and spending cuts, and the financial markets have already been pricing in the possibility of a hard landing so it might not be as bad as some doomsayers are predicting. Because even with the automatic implementation of the spending cuts and tax hikes on January 1st 2013, so long as the executive office and the legislature is working toward a resolution there is still hope. If and when a deal is brokered, those automatically triggered events could be retroactively repealed.

Deal or no deal?

The question is, of course, can a deal be brokered? There are still some very major sticking points, especially as it applies to tax rates for wealthy taxpayers (Democrats say raise the taxes for the rich and Republicans say no way) and deeper and permanent spending cuts which one side wants (Republicans) and the other (Democrats) doesn’t. How the federal government will rein in its overwhelming debt is also a major hurdle; the Republicans would like to reduce the growth rate of certain social welfare programs in order to curtail debt which is staunchly opposed by the Democrats. The middle-class seems to at least have the support of both the Democrats and the Republicans who want to protect them from additional tax increases, but in the end, with no deal, the middle class might be the one which takes the brunt of the pain.

Despite what the cockeyed optimists have to say about the fiscal cliff, it is not looking good for a great number of Americans, at least not in the near term. This session of the U.S. Congress is in office for only a few more days and after that a slew of newly sworn in Senators and Congressman will inherit the mess and that could be a drag on the time it takes for a deal to be made. In the meantime, the economy gets hit with the double whammy and the timer begins its count down toward a recession.