In 2011, when Congress and President Obama couldn’t agree on increasing the debt limit, rather than shutting down the government, the two sides agreed to a short-term mechanism, permitting the tax cuts and spending increases proposed by both sides to remain in place, but setting a deadline of December 31, 3012 for the two sides to act responsibly with each other. This date is known as the fiscal cliff.
The fiscal cliff, if it happens, will affect both parties negatively. Both Republican and Democratic constituencies will be hit hard.
As far as revenues, what will the fiscal cliff do?
* The Bush tax cuts will expire;
* The payroll tax cuts will expire;
* A large number of special tax breaks (pork barrel) will be eliminated;
* The end of the alternative minimum tax.
As we can see, it’s hard to imagine a working person who isn’t affected by one or more of these proposals. Some go after low-income workers (payroll tax), some go after middle-class families (alternative minimum tax and payroll tax); some target the well-off (special tax breaks and Bush tax cuts).
Half of deficit reduction will take place on the revenue side. The other half, obviously, takes place on the spending side. The fiscal cliff mandates the following spending cuts:
* Half of the spending reductions in the budget will take place in defense spending; the other half comes out of social spending, primarily entitlements;
* There will also be an end to extended jobless benefits;
* There will be a massive cut in subsidies to physicians for Medicaid and Medicare. This one is sort of tricky to understand. Every budget, when funds are needed, the budget mandates cuts to Medicare and Medicaid. Rather than really cutting benefits, politicians have crafted a scheme where they pretend to cut payments to doctors. Then, later on, usually during a scandal, Congress passes a supplemental bill to raise physicians’ benefits back to where they were.
These cuts will negatively affect a number of constituencies that both parties count on for support. Particularly will be military spending, which inordinately affects the South, Medicare and Medicaid, which affects the elderly and poor, the unemployed, and doctors.
Both sides had little incentive to act before now for a number of reasons. Politicians detest cutting benefits near an election, since voters tend to punish those who cut what the government gives them at the polls. As well, Democrats have repeatedly promised to maintain Medicare and Medicaid spending; Republicans have promised to not raise taxes.
What is the effect of the fiscal cliff, if it occurs? We will go into a short-term recession, as consumer spending will decline abruptly. Long-term, though, about a $trillion per year will be removed from the deficit.