UNDERSTANDING FISCAL CLIFF

In the United States, the "fiscal cliff" refers to the economic effects that will result from tax increases, spending cuts, and a corresponding reduction in the US budget deficit, potentially beginning in 2013. The deficit—the difference between what the government takes in and what it spends—is projected to be reduced by roughly half in 2013. The Congressional Budget Office estimates that this sharp decreases in the deficit (the fiscal cliff) will likely lead to a mild recession in early 2013 with the unemployment rate rising to roughly 9 percent in the second half of the year.

The laws leading to the fiscal cliff include the expiration of the 2010 Tax Relief Act and planned spending cuts under the Budget Control Act of 2011. Nearly all proposals to avoid the fiscal cliff involve extending certain parts of the Bush tax cuts or changing the 2011 Budget Control Act or both, thus making the deficit larger by reducing taxes or increasing spending. Because of the short-term adverse impact on the economy, the fiscal cliff has stirred intense commentary both inside and outside of Congress.

The Budget Control Act was a compromise intended to resolve a dispute concerning the public debt ceiling. Some major programs, like Social Security, Medicaid, federal pay (including military pay and pensions), and veterans' benefits, are exempted from the spending cuts. Spending for defense, federal agencies and cabinet departments will be reduced through broad, shallow cuts referred to as budget sequestration.

At around 2 a.m. on January 1, 2013, the Senate passed a compromise bill, the proposed American Taxpayer Relief Act of 2012, by a margin of 89–8. The bill would delay the budget sequestration by two months, and includes $600 billion over ten years in new tax revenue relative to extending 2012 levels, which is about one-fifth of the revenue that would have been raised had no legislation been passed. The revenue would come from increased marginal income and capital gains tax rates relative to their 2012 levels for annual income over $400,000 for individuals and $450,000 for couples; a phase-out of certain tax deductions and credits for those with incomes over $250,000 for individuals and $300,000 for couples, an increase in estate taxes relative to 2012 levels on estates over $5 million, and expiration of the two-year-old cut to payroll taxes, which is applied to income under the Social Security Wage Base, which was $110,100 in 2012. All these changes would all be made permanent. The House passed the bill without amendments by a margin of 257–167 around 11 p.m. EST on January 1, 2013

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