Fiscal Cliff: How Did It Come To This?

Suppose you owed $15,000 and earned $15,000. (Multiply those figures by a billion, and that’s almost what the US economy looks like.) In two weeks, your loan payments are going to increase, and your salary is going down. That’s a personal fiscal cliff – less income, more expenses.

In federal government budget speak, the fiscal cliff is about taxes going up and spending going down at the same time. Unless something is done to stop it, this will happen in the U.S. on New Year’s Day.

How did this happen?

Twelve years ago, the U.S. economy was generating surpluses – more revenue than spending – for “as far as the eye could see.” In 2001, President George W. Bush pushed a tax cut through Congress that was set to expire in ten years. Why expire? Because a ten year tax cut “costs” less than a permanent tax cut. The ten-year cost was $4 trillion. A permanent tax cut would have cost a lot more. It was the largest tax cut ever. Government revenues decreased. Not until 2006 did income tax revenues catch up to what they were in 2000.

Then, the world changed. The country entered two wars that have cost $1.5 trillion. Congress also expanded Medicare to pay for medications for seniors, another $1 trillion.

The Great Recession that began in 2008 was costly. The Bush bank bailouts cost $800 billion, the Obama stimulus mostly to state and local governments facing massive tax decreases cost another $800 billion, and recession driven unemployment and other safety net costs increased $500. Revenues also declined. Tax receipts declined more than $1 trillion compared to 2007. In fact, in 2012 tax revenues were still lower than they were in 2007.

In 2010, because of the fragile economic recovery, the Bush tax cuts were extended for along with a new payroll tax cut. Price tag for two years: $1 trillion.

The total: $6.5 trillion. A lot of money to be repaid when income tax revenues are only $1.1 trillion per year.

In 2011, Congress imposed a “sequester” automatically cutting $1.2 trillion in spending over the next ten years beginning Jan. 1, 2013. Congress thought it would replace that with a better plan within a year, but it couldn’t.

When New Years 2013 arrives, the Bush tax cuts expire taxes and the sequester spending cuts kick in. $500 billion more revenue. $100 billion less spending. That’s the cliff.

That was the plan, but, now, no one wants it.

Economists say that raising taxes and reducing spending – the ways to resolve the deficit and the debt – that much in one year may cause a recession because 70% of the economy is consumer spending, and people will have less to spend.

Democrats and Republicans agree that the deficit must be reduced by $4 trillion over the next ten years. They don’t agree how to do that. Since doing some now and more later hurts less, that’s what will happen. Taxes will increase a little on the rich and spending cuts will be reduced.

Like pulling off a band-aid slowly, this is going to be painful for a long time.

Comments are temporarily disabled.
Wed, 20 Aug 2014 02:50:17 -0400

Subscribe to our newsletter to receive the latest Georgetowner updates.