The fiscal cliff is a term used to succinctly describe the budget crisis faced by the United States government at the end of 2012.
The term was first used in 2011 by Goldman Sachs economist Alex Phillips in an article entitled, “The Super Committee and the Fiscal Cliff." The term gained traction in the media in early 2012.
When Congress passed the Budget Control Act of 2011, it created the possibility for the fiscal cliff to come about. While the term fiscal cliff had not been coined yet, the makings of it were set in place.
In an unusual move, Congress backed itself into a corner. Even though the Act postponed making the tough choices, it set a deadline for members of Congress to make the decisions they were elected to make. The Act leaves Congress with three basic options:
- Make cuts to particular budget items
- Allow automatic budget cuts to take effect
- Increase the amount the amount of money the federal government is authorized to borrow
None of these options are politically advantageous. Making specific cuts angers specific voting blocs. Allowing automatic budget cuts, or sequestration, to take effect makes lawmakers look incompetent and unable to work together. Increasing the debt ceiling makes Congress appear weak and unwilling to make hard decision.
A fourth option developed as the 2012 federal election played out -- a combination of spending cuts which republicans liked and tax increases on the wealthy which democrats liked. This reflects a basic philosophical difference between the two parties. Republicans prefer tax cuts to spur the economy while democrats prefer government intervention into the economy.
In addition to the spending cut mandates in the Act, the Bush era tax cuts and the payroll tax holiday passed during President Obama’s first term were set to expire at the end of 2012.
Threat of Sequestration:
Sequestration is an interesting entity unto itself. If lawmakers were unable to make decisions to avoid the automatic cuts, the Treasury Department was to sequester a portion of each agency’s budget as specified by the Act.
Exactly how this would play out is subject to interpretation. The Act says that budget reductions are to be applied evenly by “program, project and activity.” No one will really know what this will mean until the Treasury starts sequestering funds. Some larger programs have limited exemptions to sequestration.
Experts were divided on how extensive the pain would be to federal budgets. The cuts would come at the beginning of January, three months into the federal fiscal year. The budget cuts would be based on the full year’s budget. Agency administrators knew this for a while and were planning accordingly. They were ready to implement cuts if they became effective.
Impact of the 2012 Election:
The 2012 federal election complicated matters. The fiscal cliff loomed just beyond the November 6 election day. President Obama ensured the country that it would not go over the cliff if he was elected president, and evidently, the country believed him since he was re-elected. However, he and members of Congress were unwilling to make any decisions that might upset voters before those voters had the opportunity to cast ballots.
That left the tough choices to a lame duck Congress. The Congress is considered lame duck because some of its members were serving out their term that ended once new members were sworn into office. That placed outgoing members in an interesting position. Unlike their colleagues who needed to be concerned about how their constituents would perceive their voting record, outgoing members for the most part did not.
During and after the election, President Obama pushed the need for Congress to compromise on spending cuts and tax increases for the wealthiest Americans. Tax increases are not in line with the intent of the Act which was meant to spur Congress to reduce spending, not to add revenue to reduce the amount of money the government must borrow. Republicans continued to bluster at the idea of any tax increases, but they had to compromise with democrats to avoid going off the fiscal cliff.
Like many Congressional compromises, this one came at the latest possible moment. Congress passed legislation to fend off the fiscal cliff, but they set themselves up for more fights over sequestration and the debt ceiling mere weeks later. It was a short term solution that left members of both parties unsatisfied.
Among other provisions, the fiscal cliff deal increased personal income taxes on individuals earning more than $400,000 per year and couples earning more than $450,000; the payroll tax holiday was not extended; and estate taxes were increased.