by

Rajesh Goyal   

Knowledge Level 1  :

What is meaning of "Fiscal" and What is meaning of "Cliff"

"Fiscal Cliff" has been in news for quite some time now.   The term in the last part of 2012 is being discussed in the context of USA and thus most of Indians do not understand this.  Moreover, even the exact meaning of the  word "cliff" is not known to Indians as we have few hills around us.  So let us start with some fundamentals.

I think most of bankers understand the word "Fiscal".  This means involving financial matters.   We frequently use this like "Fiscal Year" and Fiscal Deficit".   Thus,  we will not waste further time on this word.   Coming to second word "Cliff", which is more known to people who live in hills, it means "a steep, or overhanging face of the rock, especially at the edge of sea". 

What is Fiscal Cliff :   Towards the end of 2012 in USA, the Fiscal Cliff  terms is hotly discussed.   Fiscal Cliff here refers to the economic effects that could result from (a) tax increases,  (b) spending cuts and  (c) a corresponding reduction in the US Budget deficit beginning in 2013, if the existing laws are not changed by the end of 2012.

Interestingly, there are number of scheduled measures in the US economy which are to take effect from beginning of January 2013.  If these measures are allowed to take place, the deficit in US budget (we know deficit is the difference between what the government takes and what is spends)  is likely to be reduced by almost half beginning the first days of 2013.  This kind of sudden fall in deficit in a short period of time is known as "fiscal cliff". 

Knowledge Level 2  :

What are the Components That Are Likely to Precipitate Fiscal Cliff :

We give below some of the major components relating to revenue and spending measures that are set to expire or take effect from beginning of January 2013, and can have cascading effect on the US Economy : -.

(A) Revenue Increases

• (1) (2001/2003/2010 Tax Cuts & AMT Patch. This series of legislation are popularly called the "Bush tax cuts,"  are going to expire on December 31, 2012, resulting in higher taxes on all income tax rates (e.g. the top bracket of taxes  will go from 35 to 39.6 percent), as well as rates on estate and capital gains taxes.   Similarly, the alternative minimum tax (AMT) will too automatically apply to millions more citizens.
• (2) Payroll Tax Cut. The Social Security payroll tax holiday will expire  31st December 2012, raising the rate from 4.2 to 6.2 percent.
• (3) Other Provisions. Several other policies such as the Research and Experimentation tax credit, many of which are typically enacted retroactively, are also to expire by end of 2012..
• (4) Affordable Care Act Taxes. Some provisions in the Obama health-care legislation, including increased tax rates on high-income earners, are set to take effect in January 2013.

(B) Spending Cuts :

• (i) Budget Control Act. The automatic spending cuts or sequester legislated by the Budget Control Act of 2011 will expire at the beginning of January 2012 itself.     Half of the scheduled annual cuts ($109 billion/year from 2013-2021) will come directly from the national defence budget, half from non-defense. However, some 70 percent of mandatory spending will be exempt.
• (ii) Extended Unemployment Benefits. The eligibility to begin receiving federal unemployment benefits, last extended in February, 2011, too  will expire by the end of 2012;.
• (3) Medicare "Doc Fix." The rates at which Medicare pays physicians will decrease nearly 30 percent on December 31.2012

Knowledge Level 3  :

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Impact of Fiscal Cliff i.e. If no action is taken and legislations are allowed to expire :

What is worrrying the US analysts and economists is that  federal government allowed the above two events to proceed (revenue increase and spending cuts) as planned, they could have a detrimental effect on an already shaky US economy.  The results can lead even sending the economy back into an official recession as it cut household incomes, increased unemployment rates and undermined consumer and investor confidence. At the same time, it was predicted that going over the fiscal cliff would significantly reduce the federal budget deficit.

There are wild talks that in case Congress and President Obama do not act to avert this perfect storm of legislative changes, USA will, "fall over the cliff."    Among other things, it will mean a tax increase the size of which has not been seen by Americans in 60 years.   The Tax Policy Center estimates that middle-income families are likely to pay an average of $2,000 more in taxes in 2013. Many itemized deductions will be subject to phase-out, and popular tax credits like the earned income credit

Bright Side of the Fiscal Cliff :

Certainly there are few who feel  Fiscal Cliff would  have a long-term positive impact.  These people argue  that the U.S. has to certainly tackle its deficits at some point of time.   It is better to bite the bullet at this stage and this initiative can prove a step the right direction.  Although the short-term impact could be severe (recession in 2013), the bullish argument would hold that the long-term gains (lower deficits, lower debt, better growth prospects, etc.,) would be worth the short-term pains.