The Fiscal Cliff

This is the first in a series of posts regarding policy directions for the United States during President Obama's second term.  This post concerns the "Fiscal Cliff" facing the nation in January, 2013.  The other posts are found below.

Priority #2, Reducing the Federal Deficit 
http://debatablypolitical.blogspot.com/2012/12/priorities-for-obamas-second-term-2.html
Priority #3, Immigration Reform: 

http://debatablypolitical.blogspot.com/2012/12/priorities-for-obamas-second-term-3.html

Priority #4, Tax Reform

http://debatablypolitical.blogspot.com/2012/12/tax-reform-in-united-states.html

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Priority #1, Tax Reform

 President Obama, in his second term, must necessarily focus on different priorities than his first term.  The president must somehow run the American government in a fiscally responsible manner, despite the gridlock between the parties in Congress.  He must simultaneously deal with a failing economy, international crises, other pressing domestic issues, and deliver on the Democratic social agenda. 

 Cooperation from the Republican Party, which was totally lacking in Obama’s first term, is essential to resolution of national problems in his second term.  However there is no reason to believe that the opposition will work with Obama in the second term, any more than in his first term.

I wonder why Barack Obama wanted this job.

I.  Fiscal Cliff:

The “Fiscal Cliff” refers to simultaneous increase of tax collections and reduction in government spending.  The sudden reduction in spending by both consumers and government is believed to threaten the economy, at a time when the national unemployment rate is still about 8%. 

The situation is like a losing chess game.  You can move the knight, or you can move the bishop, but in either case you will be checkmated in three moves.  If Federal spending continues unchecked we will soon face the same debt crisis seen today in Europe.  If taxes are raised or government spending is cut, the frail economy will fall into recession.  There is no winning move.

The “Bush Tax Cuts” were originally enacted in 2001 and 2003, and were extended as an economic stimulus in 2010.  These are now set to expire on December 31, 2012.  A temporary 2% reduction in Social Security tax is also set to expire.

The expiration of the low tax rates would mean an additional 500 billion dollars in tax receipts, or about 20% over current collections.  The mandatory spending cuts are relatively trivial, amounting to 110 billion, or about a 3% savings out of a budget that is running 50% over tax receipts.   A large part of the non-defense spending comes as a cap on Medicare spending.

http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-22-2012-Update_to_Outlook.pdf

If all tax and spending changes occur as currently scheduled, 641 billion dollars of deficit spending remain, according the Congressional Budget Office (CBO) baseline projection.

http://www.cbo.gov/publication/43539  (Excel table).

Projections by the CBO indicate that ”going over the cliff” (allowing automatic tax increases and spending cuts to occur) may be best for the long-term health of the nation.  However, the cost of a recession in 2013 is politically unacceptable to either party.  Obama and Congress must work quickly to adopt a solution which will maintain the strength of the economy without sacrificing the country’s long-term financial position.