Without congressional action, up to $600 billion of expiring tax cuts, new taxes, and automatic spending cuts are set to take effect at the end of 2012 or beginning of 2013.
If they hit all at once, the impact could amount to as much as 4%-5% of GDP, according to our research, the equivalent of falling off a “fiscal cliff.” Some experts anticipate the economy would experience a significant slowdown and there would be major consequences for financial markets.
Federal Reserve Chairman Ben Bernanke and a number of observers have used the term “fiscal cliff” to describe several big fiscal events set to occur in the U.S. at the end of this year and in early 2013.
- The expiration of the Bush-era tax cuts at the end of 2012, including current lower tax rates on capital gains, dividends, income, and estates, as well as number of other measures.
- The expiration of fiscal stimulus measures, such as the payroll tax cut and extended unemployment benefits.
- Spending cuts scheduled to be triggered automatically in January 2013 as a result of the failure of the deficit reduction super committee last year.
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Depending on estimates, the impact of all these actions taken together would be a fiscal shock on the order of $300 billion to $600 billion in just one year. Such policies would reduce the budget deficit and begin to address the nation’s increasingly worrisome debt situation. If the government does nothing and the spending cuts and tax increases take effect, we get a big fiscal contraction ( shrinkage). Buying bonds becomes your best bet. That’s because the fiscal contraction likely means slower growth and lower inflation, which means lower bond yields.
The best thing about it is that we may not see dire instructions. Compromise will be key among our law makers. With the election behind us, the politics of obstruction has lost its meaning. There is nothing to be gained from obstruction for obstruction’s sake. Politics will be placed aside to get the country moving.
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