What the Fiscal Cliff Really Is

Fiscal Cliff

The term: “Fiscal cliff” sounds dire, but it describes a combination of old tax breaks expiring, new tax increases and federal cutbacks that all take effect by January, 2013.

President Obama or Governor Romney can’t steer us away from the cliff—only Congress can do that, by reaching a new budget deal, ASAP. But the fiscal cliff is an election issue, since whoever gets elected will influence the negotiations.

The breakdown:

Taxes: Bush era tax cuts will expire in December; all income levels will ring in the New Year with higher taxes unless Democrats and Republicans cut a deal. A 3.5 percent increase in capital gains taxes will help cover Obamacare costs.

Middle and low income families would be affected mostly by increases in payroll taxes and cuts to earned income and child credits. If the U.S. jumps off the fiscal cliff, it’s estimated that 88% of households will pay more in 2013. The independent Tax Policy Center projects an average middle-class tax increase of about $2,000.

Spending cuts: Remember the debt ceiling fight in 2011? After that debacle, Congress agreed to more than $1 trillion in cuts to federal programs (for now, Social Security and Medicare are not affected). About $109 billion in cuts could take effect in 2013.

New cuts plus taxes could slash the annual federal deficit by $500 billion—finally putting the brakes on our debt.

The sticking points: Democrats want Bush tax breaks to expire only for the wealthy; Republicans want to keep them for everyone. Republicans oppose Obamacare funding and cuts to defense spending; Democrats oppose cutting domestic programs.

If the spending cuts and tax hikes proceed, many worry that such strong medicine could stall the economic recovery—and that unemployment could tick back over 9%. Or the economy could stabilize—and grow.

The future: No one expects a new budget deal before the election, and gridlock could continue no matter who is elected. Will we jump off the cliff in January? Buckle your seatbelt just in case.