Everything you need to know about the fiscal cliff

Washington and Wall Street are freaking out about a looming one-two punch of tax hikes and spending cuts

House Speaker John Boehner (R-Ohio) discusses the looming fiscal cliff on Capitol Hill on Nov. 7, asking President Obama to work with House Republicans.
(Image credit: Brendan Hoffman/Getty Images)

"Some reward," say Paul Wiseman and Christopher S. Rugaber at the Minneapolis Star Tribune. President Obama convincingly won a tough re-election fight, and almost immediately he has to deal with "Taxmageddon," the so-called fiscal cliff that looms before the U.S. economy on Jan. 1, 2013. The not-irrational fear that he and House Republicans won't be able to avert this calamity helped send U.S. stocks plummeting on Wednesday. But just what is the fiscal cliff, why is it such a big deal, and what's the chance we'll all drive over the edge together? Here's what you need to know:

What, exactly, is the fiscal cliff?

A combination of $536 billion in tax increases — a return of rates to 2001 levels (before the Bush tax cuts) plus an end to Obama's 2 percent payroll tax holiday and various business and investment tax breaks — plus $110 billion in spending cuts almost immediately affecting everything from the military to Medicare. The Congressional Budget Office (CBO) estimated in May that this would drain about $600 billion from the U.S. economy in the first nine months of 2013, or about $800 billion for the whole year (though it recently revised its outlook to show a somewhat smaller impact). The phrase "fiscal cliff" was coined by Federal Reserve Chairman Ben Bernanke, and he didn't mean it in a good way.

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How would that affect me?

According to an Oct. 1 analysis by the Tax Policy Center, the fiscal cliff would increase taxes for 90 percent of Americans, by an average of about $3,500 per household. There's a pretty big spread contained within that average — the lowest 20 percent of earners would have to pay $412 more a year (a 3.7 percent cut in after-tax income), the top 1 percent would pay an extra $120,000 a year (a 10.5 percent hit), and those earning $40,000 to $65,000 a year would pay an average of $2,000 more a year (a 4.4 percent cut in income) — but all in all, the complicated patchwork of expiring provisions constitute an "unprecedented tax increase."

Who thought this would be a good idea?

Nobody, really. A sizable majority of Washington, including Obama, wants some of the tax rates to stay put, at least for now; the question is whether to keep all of the lower rates, as the GOP demands, or raise taxes for just the wealthy, as Democrats insist. We're at this point largely because the two sides couldn't resolve that conflict at the end of 2010, the last time the Bush-era tax cuts were scheduled to expire. The package of steep spending cuts, or sequester, was Congress' idea, a cudgel to force its own "supercommittee" to agree on a binding plan to reduce the deficit; they didn't.

Would driving off the fiscal cliff really be so awful?

Some economists argue that while the short-term pain would be bad, it might be worth the reward: Taming the national debt without having to do anything else. But most analysts say the one-two punch of big cuts and sharply higher taxes would be too strong a shock to the recovering economy. "Going over the fiscal cliff would mean allowing a massive and immediate cut to nearly every major government agency and activity, including those vital to our national security or economic growth," argues Erskin Bowles in The Washington Post. "It would mean a double-dip recession at a time when the economy is still very weak and many Americans are struggling to find work."

What are lawmakers going to do about it?

That's the $800 billion question. Obama campaigned pretty heavily on raising taxes for the wealthiest Americans, and has pledged to veto any fiscal-cliff solution that doesn't do that. House Speaker John Boehner (R-Ohio) — now "the undisputed leader of the Republican Party," says The Washington Post's Dana Milbank — made conciliatory noises after the election about the House GOP agreeing to "accept some additional revenues" as part of a broad deal that reforms entitlements and the tax code, but it's not clear if he's offering anything new. And he also said that since they kept control of the House, Republicans "have as much of a mandate as [Obama]... to not raise taxes," notes an unconvinced David Weigel at Slate. The great Beltway hope is that Obama and Boehner will seal a comprehensive "Grand Bargain," and that their parties will go along with it. They have 49 days. Stay tuned.

Sources: ABC News, The Associated Press, Hot Air, Slate, Urban Institute, The Washington Post (2,3,4), The Week

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