Economix: What is the Fiscal Cliff anyway?

By Kara Odum ’15Economics Columnist

On Jan. 1, Congress narrowly avoided the fiscal cliff by preventing the Budget Control Act of 2011 from going into action.

If Congress had taken no action, multiple tax increases would have gone into effect, including an end to temporary payroll tax cuts, the start of Obamacare taxes, and the repeal of certain tax breaks for business. Also scheduled were spending cuts for over 1000 government programs including defense and Medicare budgets. By increasing taxes and decreasing spending, these changes would have created a sharp decline in the budget deficit, so much so that the deficit was projected to be reduced by roughly half in 2013. The government deficit, the amount by which the government spending exceeds its revenue, is often confused with the government debt, the aggregate sum of what the U.S. government owes to debt holders.

While the U.S. has been working to reduce the budget deficit, the changes would have had an adverse effect on the recovering economy. Many economists predicted that the U.S. would have experienced a mild recession along with a higher unemployment rate if nothing had been done.

Congress averted the fiscal cliff by passing the American Taxpayer Relief Act, which Obama signed on Jan. 2. The act eliminated most of the tax increases and spending cuts. However, some tax exemptions were allowed to expire, which resulted in a projected $157 billion decline in the 2013 deficit.

Spending cuts were temporarily averted, but budget sequestration has been delayed for two months. Budget sequestration occurs when Congress’ spending exceeds the annual Budget Resolution, which triggers automatic reductions across the board so that the budget will balance. An equal percentage is supposed to be held back by the Treasury from all departments and programs but Congress has exempted Social Security, Medicaid, federal pay, and veterans’ benefits from these cuts. In order to do this, Congress must cut more from non-exempt programs.

In March, Congress will be faced again with budget sequestration, which was originally a part of the deal in July 2011 to raise the debt ceiling.

At the end of 2012 the U.S. had once again hit its current authorized borrowing limit at $16.4 trillion. Through a series of “extraordinary measures,” Treasury Secretary Timothy F. Geithner has been able to avoid going above the debt ceiling temporarily. However, in early March, Congress will have to raise the debt ceiling again so the Treasury Department can continue to pay for what Congress has already approved. If the debt ceiling is not raised then Congress will not have enough revenue to cover its obligations.

While the U.S. would probably avoid defaulting, it would still have a negative effect on the economy because faith in the U.S. economy would be shaken, sending interest rates up. This would create a vicious cycle, since the U.S. would have to borrow to cover current obligations but at a higher interest rate, so overall the debt would still rise.

As of now, Congress is not considering the drastic measures necessary to end this cycle of borrowing more money, raising the debt ceiling. Until then, the U.S. will have to deal with “fiscal cliffs” every few months.