The Fiscal Cliff Explained
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The Fiscal Cliff Explained “Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect. Among the changes that were set to take place at midnight on December 31, 2012 were the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would take a larger bite, a rollback of the "Bush tax cuts" from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. According to Barron's, over 1,000 government programs - including the defense budget and Medicare are in line for "deep, automatic cuts." Of the two, the tax increases were seen as the larger burden for the economy. The Fiscal Cliff Deal Three hours before the midnight deadline on January 1, the Senate agreed to a deal to avert the fiscal cliff. The Senate version passed two hours after the deadline, and the House of Representatives approved the deal 21 hours later. The government technically went "over the cliff," since the final details weren't hashed out until after the beginning of the New Year, but the changes incorporated in the deal will be backdated to January 1. The key elements of the deal are: an increase in the payroll tax by two percentage points to 6.2% for income up to $113,700, and a reversal of the Bush tax cuts for individuals making more than $400,000 and couples making over $450,000 (which entails the top rate reverting from 35% to 39.5%). Investment income is also affected, with an increase in the tax on investment income from 15% to 23.8% for filers in the top income bracket and a 3.8% surtax on investment income for individuals earning more than $200,000 and couples making more than $250,000. The deal also gives U.S. taxpayers greater certainty regarding the alternative minimum tax, and a number of popular tax breaks - such as the exemption for interest onmunicipal bonds - remain in place. The Congressional Budget Office estimates that current plan includes $330.3 in new spending during the next ten years, and it will increase the deficit by $3.9 trillion in that time period despite raising taxes on 77.1% of U.S. households. Bloomberg reports, "More than 80 percent of households with incomes between $50,000 and $200,000 would pay higher taxes. Among the households facing higher taxes, the average increase would be $1,635, the policy center said. A 2 percent payroll tax cut, enacted during the economic slowdown, is being allowed to expire as of (December 31)." The two-percentage point increase in the payroll tax is expected to take about $120 billion out of the economy, which should have a negative impact of about seven-tenths of one percent on GDP growth. Did the Deal Accomplish Anything? The fiscal cliff agreement is good news to some extent, although it shouldn't be ignored that lawmakers had 507 days (since the August, 2011 debt ceiling agreement) to address this problem, but still came down to the final hours before they were able to reach a solution - an unnecessary,
self-inflicted burden on the economy and financial markets. What's more, the agreement addressed only the revenue side (taxes) but postponed any discussion of spending cuts for another two months. Also, it's important to keep in mind that higher taxes were the most important element of the cliff, and taxes are in fact going up as part of the deal. While the problem is therefore "solved" in the sense that the debate is over, a portion of the concerns related to the cliff indeed came to fruition. And on a longer-term basis, the cliff deal did little to address the country's debt load - which currently stands at $16.4 trillion and counting. The 2012 Fiscal Cliff Debate In dealing with the fiscal cliff, U.S. lawmakers had a choice among three options, none of which were particularly attractive:
They could have let the policies scheduled for the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – go into effect. The plus side: the deficit would have fallen significantly under the new set of laws.
They could have cancelled some or all of the scheduled tax increases and spending cuts, which would have added to the deficit and increased the odds that the United States would face a crisis similar to that which is occurring in Europe. The flip side of this, of course, is that the United States' debt would have continued to grow. They could have taken a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth. This is ultimately the course lawmakers choice in the agreement reached on December 31, 2012.
The fiscal cliff was a concern for investors and business since the highly partisan nature of the political environment made a compromise difficult to reach. Lawmakers had well over a year to address this issue, but Congress – mired in political gridlock – put off the search for a solution until the eleventh hour, rather than seeking to solve the problem directly. In general, Republicans wanted to cut spending and avoid raising taxes, while Democrats sought a combination of spending cuts and tax increases. The agreement currently on the table raises tax rates to 39.6% from 35% on individual with income of more than $400,000 and on couples with incomes of more htan $450,000. It also lets the 2% payroll tax cut expire and delays spending cuts for another two months. The likely outcome of these changes is that economic growth will be pressured modestly, but the country will not face the severe economic downturn it would have if all of the laws related to the fiscal cliff had gone into effect. The Worst-Case Scenario If the current laws slated for 2013 had become law, the impact on the economy would be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the CBO also estimated that the policy would have reduced gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession (i.e., negative growth). At the same time, it predicted that unemployment would rise by almost a full percentage point, with a loss of about two million jobs. A Wall St. Journal article from May 16, 2012 estimated the following impact in dollar terms: “In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts; $125 billion from the expiration of the Obama payroll-tax holiday; $40 billion from the expiration of emergency unemployment benefits;
and $98 billion from Budget Control Act spending cuts. In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that.” Amid an already-fragile recovery and elevated unemployment, the economy was not in a position to avoid this type of shock. The Term "Cliff" is Misleading It's important to keep in mind that while the term “cliff” indicated an immediate disaster at the beginning of 2013, this wasn't a binary (two-outcome) event that would have ended in either a full solution or a total failure on December 31. There were two important reasons why this is the case: 1) If all of the laws went into effect as scheduled and stayed in effect, the result would undoubtedly be a return to recession. However, the chances that such a deal wouldn't be reached were slim despite the length of time it took to come to an agreement. 2) Even if the deal did not occur before December 31, Congress had the options to change the scheduled laws retroactively to January 1 after the deadline. With this as background, it's important to keep in mind that the concept of "going over the cliff" was largely a media creation, since even a failure to reach a deal by December 31 never ensured that a recession and financial market crash would occur. The Next Crisis Unfortunately, the fiscal cliff isn't the only problem facing the United States right now. At some point in the first quarter, the country will again hit the "debt ceiling" - the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff. To learn more about this issue, see my article What is the Debt Ceiling? A Simple Explanation of the Debate and Crisis. Learn more: Fiscal Cliff Definition: The fiscal cliff is a combination of four tax increases and two spending cuts that are scheduled to automatically take place on January 1, 2013. The tax increases occur when the Bush tax cuts, the 2% payroll tax holiday and the extension of the alternative minimum tax waiver all expire on December 31,
2012. When the Bush tax cuts expires, the tax rates will increase as follows: Income taxes: revert toClinton-era rates. Capital gains tax: from 15% to 20%. Dividend taxes: from 15% to more than 43%.
Estate taxes: from 35% to 55%, depending on the size of the estate. Investors also avoided a potential 3.8% hike on capital gains and dividends as a result of Obamacare taxes.(Source: CNBC, Wealthy Dump Assets, November 12, 2012)
The expiration of the payroll tax cut means workers will see an additional 2% taken out of the paycheck to go toward Social Security. Without a waiver, the alternative minimum tax will apply to 21 million more workers, making as little as $50,000 a year.
The next day, the Obamacare taxes kick in. This is additional income and investment taxes on family incomes above $250,000. The spending cuts occur when the extended unemployment benefits expire and an across-the-board 10% Federal budget cut kicks in. It's called a fiscal cliff because Federal taxes and spending are managed by fiscal policy. It's a cliff because the effect of increased taxes and decreased spending happening at once is like pushing the economy off a cliff. The term was coined by Federal Reserve Chairman Ben Bernanke in February 2012 when he warned the House Financial Services Committee,"Under current law, on Jan. 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases..." (Source: The Hill,Bernanke Warns of Massive Fiscal Cliff, February 29, 2012) However, the term "fiscal cliff" has been in use since 1987, when the Boston Globe used it to describe a local utility's financial situation. It was used again in 1991 by California Representative Henry Waxman, referring to Oregon's budget. (Source: Oxford Dictionary) Fiscal Cliff 2012: The fiscal cliff negotiations became a critical issue after the 2012 Presidential election. First President Obama developed a plan A, then House Speaker Boehner responded with a Plan B. Uncertainty around the outcome kept economic growth lower than needed to reduce unemployment. That's because most businesses had to be conservative, and follow operational plans that included the fiscal cliff scenario. For more, see Fiscal Cliff 2012. Fiscal Cliff 2013: What happens in 2013 if nothing is done? Here's some of the major changes: On average, taxes will go up $2,000 to $3,000 per household. Around 26 million taxpayers will become eligible to pay the Alternative Minimum tax, originally set up to capture wealthy tax dodgers. However, since it wasn't indexed for inflation, it will raise taxes for many middle income taxpayers by as much as $3,700.
Roughly two million jobseekers will lose extended unemployment benefits. There will be a $55 billion cut in military spending, resulting in temporary job losses. Most other departments will be cut 8%. This includes aid to states, highway construction and the FBI. (Source: CNBC, Cliff Plunge: All But Impossible to Avoid the Pain, November 13, 2012; Forbes, The Fiscal Cliff Explained,
November 10, 2012) To make matters worse, Federal spending is likely to exceed the debt ceiling, currently at $16.394 trillion, early in 2013. If Congress doesn't raise the ceiling, the nation will go into adebt default. President Obama tried to make raising the debt ceiling part of the fiscal cliff negotiations. For updates, see Fiscal Cliff 2013. How the Fiscal Cliff Affects the Economy: The tax hikes and spending cuts would remove $607 billion from the economy in the first nine months of 2013 (that's the remainder of the 2013 Fiscal Year), according to the Congressional Budget Office. Although it's good long-term to reduce the deficit, in the short term it will severely retard economic growth. That's because government spending is an important component of the Gross Domestic Product (GDP). Suddenly cutting it by 10% or so would mean broken contracts with businesses, fewer government jobs and reductions in benefits.
The tax increases would reduce consumer spending by that amount. The net effect, according to the CBO, would be a 1.3% contraction in the economy for the first half of the year. In other words, a recession. Although the economy would recover in
the second half, the growth would be anemic -- barely 2%, or the low end of a healthy economy. Most legislators agree that this can't be allowed to happen. How the Fiscal Cliff Affects You: The fiscal cliff has already affected you by slowing economic growth. As a result of the impending uncertainty, businesses have postponed hiring and expansion. This makes it harder for the unemployed to find a good job.
In 2013, if nothing is done, the economy will go back into recession. That means you might lose your job, especially if you just got it, as businesses tend to lay off the most recently hired first.
The fiscal cliff will impact some more than others. The long-term unemployed will lose their extended benefits. Everyone will have to pay more in payroll and income taxes. Those dependent on government contracts may lose the Federal government as a customer, while Federal employees may get laid off. What Caused the Fiscal Cliff?: In 2011, the President and a Democrat-controlled Senate disagreed with the Republican-controlled House on the the best ways to reduce the deficit and debt. As government spending approached the debt ceiling, both parties finally agreed to appoint a bipartisan commission to propose a solution. The subsequent Simpson-Bowles Report was, unfortunately, ignored. Instead, Congress passed the Budget Control Act, which mandated a 10% spending cut. This was intended to be so severe that it would force Congress to act.
The impasse was basically in three main areas:
1. 2. 3.
The Democrats refused to extend the Bush tax cuts for families making $250,000 or more. The Republicans refused to extend the tax cuts for anyone if everyone can't have them. The Democrats would rather cut more out of defense spending, while the Republicans would rather cut Social Security, Medicaid and Medicare. In addition, the Republicans want to repeal the Obamacare taxes.
This standoff was a little bit of political posturing in advance of the 2012 Presidential election. With that behind us, it looks more hopeful that both parties will find enough of a common ground to avoid falling off the fiscal cliff and plunging the economy into recession.Article
US Fiscal Cliff 2013
n New Year's Day, the House approved a Senate bill that averted the fiscal cliff. Republicans were unhappy that there weren't more spending cuts, but at least an income tax hike was averted for most Americans.
Here's what the new bill contained:
1. 2. 3.
Bush tax cuts were kept on incomes below the threshold ($400,000 for individuials, $450,000 for married couples). Incomes at and above the threshold will now be taxed at 39.6%. Capital gains and dividends taxes were raised from 15% to 20% for families at the threshold and above. Estate taxes were raised to 40% of estates above $5 million for those at and above the threshold. The 2% payroll tax credit was allowed to expire.
4. 5. 6.
The income level at which the alternative minimum tax kicks in was permanently raised, so it doesn't affect middleincome taxpayers. It is indexed for inflation, so that it doesn't have to be patched year after year. The extended unemployment benefits will continue for a year. Sequestration has been postponed for two months. The spending cuts that Republicans want will be part of the normal FY 2014 budget negotiations -- as they should be.
Other Provisions of the Bill Some exemptions and deductions were extended, such as the mortgage insurance premium (through 2013), the American Opportunity Tax Credit (through 2017) and the Earned Income Tax Credit (permanently). Others will be limited on incomes above $250,000 ($300,000 for married couples. For details on these, see House Approves Taxpayer Relief Act.
The bill takes action on other important points:
It prevents a 37% decline in Medicare payments to doctors. It extends federal dairy subsidies through the end of FY 2013. This prevents a hike in milk prices. It does not include a .5% pay raise for Congress proposed by President Obama.
Like most other legislation, the bill contained some last-minute riders to provide a hodge-podge of smaller tax exemptions for special interest groups. These range from tax breaks for NASCAR, Hollywood, and AMTRAK. For more, see Wonkblog, 10 Wierdest Parts of the Fiscal Cliff Deal. What Made the Vote Possible: We actually fell off the fiscal cliff for barely 24 hours. Since all Bush tax cuts expired, Tea PartyRepublicans can't be accused of raising taxes. Instead, they reinstated the tax cuts for incomes at $400,000 or less, and then instituted a smaller tax cut for incomes above that amount. Congress wanted to vote on the measure before newly elected members took office on Thursday. This shifted the voting power more toward the Democrats, even though the House retained a Republican majority. For more, see House Approves Fiscal Cliff Bill -- What It Means to You. The Disaster That Was Averted: The fiscal cliff refers to the devastating impact on the economy in 2013 if national leaders allowed four tax increases and two spending cuts to take place at the beginning of the year. According to the Congressional Budget Office, $607 billion in government stimulus would have been removed from U.S. Gross Domestic Product (GDP) between January and September 2013 (These dates correspond to the last nine months of the 2013 Fiscal Year.) Two-thirds of that ($339 billion) would have resulted from the following tax increases: 1. Expiration of Bush tax cuts and the ARRA - $229 billion. 2. Expiration of the 2% payroll tax holiday, part of the Obama tax cuts, - $95 billion. 3. 4. Expiration of partial expensing of investment properties - $65 billion. Obamacare tax increases - $18 billion.
The rest would have come from the following reductions in Federal spending: 1. Sequestration (automatic budget cuts) - $65 billion. 2. 3. Expiration of extended unemployment benefits - $26 billion. Reduction in Medicare payments to doctors - $11 billion.
Other, unspecified changes that reduced the deficit by another $105 billion.
Worst Case Scenario: There was never a real chance that nothing would be done, the worst case scenario. No elected official wanted to be responsible for allowing a recession. That's what the Congressional Budget Office (CBO) predicted, saying the economy would contract 1.3% for the first two quarters of 2013. Even though the CBO projected that the economy would recover, growing 2.3% in the second half of the year, it would have caused more unemployment while only reducing the deficit by $560 billion. That's because people who have been laid off pay less in taxes, translating to lower revenue for the government. Best Case Scenario: The best case scenario would have been if Congress extended all tax cuts and kept spending at current levels. In that case, the economy would have grow 4.4% in 2013 according to the CBO. At that growth rate, job creation would rise and the unemployment rate would drop. That would pretty much eliminate the need for extended unemployment benefits, as they are tied to aboveaverage state unemployment rates. More income from wages means that tax revenue would rise, reducing the deficit and debt. A healthy economy can grow its way out of a high debt-to-GDP ratio. The higher the GDP, the lower the ratio -- as long as spending doesn't increase. For proof, notice that the national debt by year keeps increasing. Even though the debt from World War II has never been paid off, it doesn't matter. Economic growth has since dwarfed it. However, it's highly unlikely that Congress would support this scenario. Way too many elected officials think that the Federal debt is unsustainable at even a 90% debt-to-GDP ratio. (Source: CBO, Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013, May 2012) Article updated January 3, 2013
The Fiscal Cliff and its Impact on Small Business
November 12, 2012 Even before President Obama was re-elected, there were discussions about the "fiscal cliff" that exists at the end of 2012 and the danger of the U.S. falling off this fiscal cliff. What is the fiscal cliff and how does it impact small businesses? The fiscal cliff is the term used for the man-made, or politican-made, problem that has resulted because of the inability of the Congress and the President to work together during President Obama's first term in office. As a result of that stalemate, there are a number of significant financial events taking place at the end of the year that, together, could constitute a severe economic contraction and a drop in our gross domestic productduring 2013. When the politicians, over the last few years, could not reach an agreement about one issue or another, they just kept putting off the decisions or "kicking the can down the road." None of the big problems ever got solved. The fiscal cliff resulted when the deadline for all these problems is happening at once at the end of 2012. These financial problems are a series of tax hikes and spending cuts by the federal government that will happen unless the federal government takes some sort of action by 12/31/2012. This is called thefiscal cliff. The Congressional Budget Office projects that around $800 billion in tax hikes and spending cuts will happen in 2013 if the decisions the politicians refused to make go unmade again this year. What Composes the Fiscal Cliff?
Bush Tax Cuts: The Bush tax cuts will expire on 12/31/2012. President Obama wants to renew the Bush tax cuts for everyone who makes under $250,000. The Republican Housewants to renew the Bush tax cuts for everyone including those who make more than $250,000. This is going to be one of the arguments over the fiscal cliff. The first Bush tax cut, in 2001, was enacted to stimulate the economy during the 2001 recession. The second Bush tax cut increased tax deductions for small businesses and lowered the capital gains tax from 20% to 15%. Never did anyone imagine that these tax cuts would become such a political hot potato so many years later. Most think tanks and economists think that dropping the Bush tax cuts for those with incomes over $250,000 will not substantially hurt small business. A Treasury Department study found that only 2.5% of small businesses are in the tax brackets with incomes above $250,000. The claims that allowing the Bush tax cuts for the top tax brackets to expire would negatively affect small business are misleading. There are other provisions in the Bush tax cuts that affect primarily individuals and might affect some small businesses. These provisions include the expiration of tax cuts on income, investments, the married couples benefit, tax provisions for families with children, and protection for inheritances. In addition to the Bush era tax cuts that will be lost, other issues on the table that comprise the fiscal cliff are the expiration of unemployment benefits for the long-term jobless, a large reduction in reimbursements to doctors participating in Medicare, the imposition of the alternative minimum tax on 26 million additional households, the expiration of President Obama's 2% payroll tax holiday, and a number of smaller cuts for households and businesses. Automatic Spending Cuts: Last year, Congress failed to reach any sort of bipartisan agreement on debt-reduction. As a result, the Budget Control Act was passed. The provisions of this Act requires that automatic spending cuts begin on January 2, 2013 that will reduce the deficit by $1.2 trillion over 10 years. Just the 2013 portion of the spending cuts will take a deep chunk of money out of the economy. Discretionary defense spending will sustain a deep cut of $55 billion in 2013. Nondefense spending will also be cut by $55 spending including programs like education. What can be Done to Avert a Crisis? This situation is quite serious and is the results of complications of a political impasse between Congress and the White House between about 2013 and the present day. One can think back to the beginning of the first term of the President in 2008 and remember that Kentucky Senator, Mitch McConnell stated that his entire mission for the next four years was to make sure that Obama was a one-term President. With thinking like that on Capitol Hill, no wonder nothing can be accomplished - and now look where it has gotten us. Not only do Congress and the President have to find a way to compromise by the end of the year for the good of the American people, but they also have to do this for the credit rating of the U.S. Government. When the U.S. Congress and White House had such a bitter fight over the debt ceiling in 2011, Standard and Poor's downgraded our debt from AAA to AA+. However, there are three credit reporting agencies. Now, both Fitch and Moody's credit reporting agencies have said that failure to reach a bipartisan compromise on a debt-reduction plan by the end of the year will cause them to lower the U.S. credit rating as well.
What is likely to happen is another hard-fought compromise that moves us forward very little. The politicians can cancel some or all of the tax hikes and spending cuts which would greatly increase the debt of the U.S. and throw us into a debt crisis approaching the one facing Europe. On the other end of the spectrum, they could let the tax hikes and spending cuts go into effect. The deficit would be cut substantially but the average American family would be hurt as well as American businesses. A middle of the road compromise, if our politicians can compromise, is available. It is hard to know what the middle of the road approach would look like but it would probably involve some combination of keeping part of the Bush tax cuts and either stopping the automatic spending cuts or substantially cutting them back. What I see in the President's future is the absolute necessity to find a way to compromise with the Republican House, not just on the fiscal cliff but on everything that comes afterward. The President and the Congress have a big, difficult job ahead. If you have solid opinions on these issues, write your Congressman. One of the other About.com Websites has great information about how to go about doing that. Check it out here.
U.S. National Debt Clock
hat Is the U.S. National Debt Clock?: The national debt clock tracks the U.S. debt. It's located on West 44th Street and Avenue of the Americas in New York. It was conceived by Seymour Durst, who put the first national debt clock up at Sixth Avenue and 42nd Street on February 20, 1989, when the national debt was nearing $2.7 trillion and 50% of GDP. Durst said, “If it bothers people, then it's working.” The debt clock faithfully recorded the increasing U.S. debt until 2000, when the prosperity of the 1990s created enough revenue to reduce the federal budget deficit and debt. It seemed as if the debt clock had done its job. The Debt Clock Tracks the Growing U.S. Debt: Unfortunately, that prosperity didn’t last. The 2001recession and the 9/11 terrorist attacks meant lower revenues, higher spending and more deficits to add to the debt. The clock was reactivated in July 2002, and then moved in 2004. When the debt exceeded $10 trillion in September 2008, one more digit was added. It took 13 years for the debt to double. By 2002, it had grown to $6 trillion, but only 46% of GDP, around $45,000 per household. It only took eight years to double again. The $700 billion bailout and raised it to $12 trillion in 2010, which was 85% of GDP and $86,000 per household.
The debt reached a new record on August 31, 2012. That's when it reached $16 trillion. This made the debt bigger than annual economic output, as measured by Gross Domestic Product, which was $15.6 trillion as of the second quarter of 2012. In addition to installing the clock, Durst bought ads on the front page of the New York Times. His May 26, 1991 message was prophetic: "Federal debt soaring, national economy shrinking, soon the twain shall meet." (Source: Times Magazine, The Times Square Debt Clock, October 14, 2008)
How much is the debt now? You don't need to fly to New York and see the debt clock to find out. Simply go to the U.S. Treasury web site: Debt to the Penny. Why Is the U.S Debt Clock Important?:
The debt clock shows how much the U.S. government owes its citizens, other countries and itself. Since 79% of its revenue comes from individual taxes, that means it is counting on you to pay it back one day. And, since corporations can pass their tax costs through to you by raising prices, this means that essentially 100% of the debt must be paid by you, your children or your grandchildren through higher taxes. Uncertainty about when taxes will be raised dampens expectations of future economic growth. This threatens to lower the quality of life for future generations. Second, increasing debt means the government is becoming more involved in your life through the programs the debt is paying for. Third, since much of the debt is financed by loans from foreign governments, they now have a voice in what happens in the U.S. Fourth, as the debt approaches the debt ceiling, politicians must vote to raise the ceiling. If the vote fails, as the Greek government did in early 2010, the U.S. could be plunged into crisis. In short, the higher the debt, the greater the risk of fiscal crisis. By watching the national debt clock, you will be aware of this risk, and how much you ultimately owe. Why the Debt Keeps Growing:
The debt is an accumulation of budget deficits. Year after year, the government cut taxes and increased spending. In the short run, the economy and voters benefited from deficit spending. Furthermore, foreign debt holders like China and Japan, allow the U.S. to run a large tab because it's such a good customer. They haven't demanded the higher interest payments that usually keeps government debt in check. How Is the Debt Financed?: The U.S. national debt is the sum of all outstanding debt owed by the Federal Government. Nearly two-thirds is the public debt, which is owed to the people, businesses and foreign governments who bought Treasury bills, notes and bonds. The rest is owed by the government to itself. Most of this is owed to Social Security and other trust funds, which were running surpluses. These securities are a promise to repay these funds when Baby Boomers retire over the next 20 years. (Source: U.S. Treasury, Debt FAQ) The Debt Clock Warning: Two factors that allowed the U.S. debt to grow are now being withdrawn. First, the Social Security Trust Fund took in more revenue through payroll taxes leveraged on Baby Boomers than it needed. Ideally, this money should have been invested to be available when the Boomers retire. In reality, the Fund was "loaned" to the government to finance increased deficit spending. This interest-free loan helped keep Treasury Bond interest rates low, allowing more debt financing. However, it's not really a loan, since it can only be repaid by increased taxes when the Boomers do retire. Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore, this lessening of demand is putting downward pressure on the dollar. That's because dollars, and dollar denominated Treasury Securities, are becoming less desirable, so their value declines. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand. How the Federal Debt and Deficit Are Different: The U.S. Federal Deficit is when government spending is greater than revenue received for that year. In Fiscal Year 2011, the budget deficit was projected to be $1.267 trillion. The FY 2010 deficit was $1.57 trillion.
By the end of 2011, the U.S. Federal Debt was more than $15 trillion. This is more than double the debt in 2000, which was $6 trillion. How Does the Deficit Affect the Debt?: Each year, the deficit is added to the debt. The Treasury must sell Treasury bonds to raise the money to cover the deficit. This is known as the public debt, since these bonds are sold to the public. In addition to the public debt, there is the money that the government loans to itself each year. This money is in the form of Government AccountSecurities, and it comes from the Social Security Trust Fund. These loans are not counted as part of the deficit, since they are all within the government. However, as the Baby Boomers retire, they will begin to draw down more Social Security funds than are replaced with payroll taxes. These benefits will need to be paid out of the general fund. This means that either other programs must be cut, taxes must be raised or benefits must be lowered. Unfortunately, legislators have not yet agreed on an effective plan to meet Social Security obligations. How Does the Debt Affect the Deficit?: The debt affects the deficit in three ways. First, the debt actually gives a better indication of the true deficit each year. You can more accurately gauge the deficit by comparing each year's debt to last year's debt. That's because the budget deficit, as reported in each year's budget, does not include the amount owed to the Social Security Fund. However, this is a debt that will need to be repaid one day, and so the amount borrowed from it is a more accurate description of each year's government liabilities than the reported budget deficit. (Source: St. Louise Federal Reserve, Deficit, Debts and Trust Funds, August 2006) Second, the interest on the debt is added to the deficit each year. About 5% of the budget is allocated to debt interest payments. Interest on the debt hit a new record in FY 2011, reaching $454 billion. This beat its prior record of $451 billion in FY 2008 -- despite lowerinterest rates. By 2020, the interest payment is projected to quadruple to $840 billion, making it the fourth largest budget item. (See Budget Spending) Third, the debt can decrease tax revenue, thereby further increasing the deficit. As the debt continues to grow, creditors can become concerned about how the U.S. government plans to repay it. Over time, these creditors will expect higher interest payments to provide a greater return for their increased perceived risk. Higher interest costs dampen economic growth. How Does the Deficit and Debt Affect the Economy?: Initially, deficit spending and the resultant debt can increase economic growth. This is especially true in arecession. That's because deficit spending pumpsliquidity into the economy. Whether the money goes to jet fighters, bridges or education, it ramps up production and creates jobs. However, not every dollar creates the same number of jobs. In fact,military spending creates 8,555 jobs for every billion dollars spent. This is less than half the jobs created by that same billion spent on construction. For more, see Unemployment Solutions. In the long run, the resultant debt is very damaging to the economy, and not only because of higher interest rates. The U.S. government may be tempted to let the value of the dollar fall so that the debt repayment will be in cheaper dollars, and less expensive. As this happens, foreign governments and investors will be less willing to buy Treasury bonds, forcing interest rates even higher. The greatest danger comes from the debt to Social Security. As this debt comes due when Baby Boomers retire, funds will need to found to pay them. Not only could taxes be raised, which would
slow the economy, but the loan from the Social Security Trust Fund will stop. More and more of the government's spending will need to be devoted to pay this mandatory cost. This would provide less stimulation, and could further slow the economy. (Article updated January 2, 2012)
U.S. Debt by President
What's the best way to determine how much of the $16 trillion U.S. debt is attributable to each President? The most popular way is tolook at the debt level when each President took office. Sometimes it's easier to look at a graph showing the percent of the debtaccumulated under each President. It's also important to compare the debt as a percent of economic output. However, these aren't the most accurate ways to measure the debt contributed by each President. Why? The President doesn't really have much control over debt accumulation during his first year. That's because the budget for that fiscal year was already set by the previous President. The new President pretty much has to live with that budget's tax rates and spending levels for the first nine months of his inaugural calendar year in office. You really can't hold him accountable for the debt incurred by the previous President's budget. In rare cases, a President can add an amendment to that budget, but must first get Congressional approval. For example, President Obama inherited President Bush's FY 2009 budget. In March 2009, he got Congress to pass the Economic Stimulus Act. This added a year's worth of stimulus spending to the FY 2009 budget. The Best Way to Measure Debt by President:
Therefore, the most accurate way to measure the debt by President is to sum all the budget deficits. That's because the President is responsible for his budget priorities. It takes into account spending, and anticipated revenue from proposed tax cuts or hikes.
There are a few caveats, however. First, Congress does have a role, since it must approve the budget. Second, each President inherits a previous President's policies. For example, every President has had to compensate for lower revenue thanks to President Reagan's tax cuts. That's because tax increases are a sure way to prevent re-election.
Third, while every President has had to deal with a recession, all recessions were not created equal. Furthermore, some Presidents have had to deal with unusual events, like the 9/11 terrorist attack and Hurricane Katrina. While these weren't part of the business cycle, they required responses that came with economic price tags. President Barack Obama: President Obama contributed the most to the debt, with cumulative deficits totaling $5.073 trillion in just four years. Obama's budgets included the economic stimulus package, which added $787 billion by cutting taxes, extending unemployment benefits, and funding job-creating public works projects. The Obama tax cuts added $858 billion to the debt over two years. Obama's budget included increased defense spending to around $800 billion a year. Federal income was down, thanks to lower tax receipts from the 2008 financial crisis. Both Presidents Bush and Obama had to contend with higher mandatory mandatory spending forSocial Security and Medicare. He also sponsored thePatient Protection and Affordable Care Act, which was designed to reduce the debt by $143 billion over 10 years. However, these savings didn't show up until the later years. President George W. Bush: President Bush is next, racking up $3.294 trillion over two terms. He responded to the attacks on 9/11 by launching the War on Terror. This drove military spending to a new records, between $600-
$800 billion a year. President Bush also responded to the 2001 recession by passing EGTRRA and JGTRRA, otherwise known as the Bush tax cuts. President Ronald Reagan: President Reagan added $1.412 trillion to the debt during his two terms. He fought the 1982 recession by cutting the top income tax rate from 70% to 28%, and the corporate rate from 48% to 34%. He also increased government spending by 2.5% a year. This included a 35% increase in the defense budget, and an expansion of Medicare. Although $1.412 trillion doesn't sound like a lot, compared to 2012 debt levels, in fact Reagan's economic policiesdoubled the debt during his Presidency. President George H.W. Bush: President George H.W. Bush added $1.03 trillion to the debt in one term. He responded to Iraq's invasion of Kuwait with Desert Storm. He oversaw the $125 billion bailout to end the1989 Savings and Loan crisis. Part of his debt contribution was due to lost tax revenue from the 1991 recession. Although many other Presidents added to the debt, none comes close to these four in terms of overall spending. Part of that is because the U.S. economy, as measured by GDP, was so much smaller for other Presidents. For example, in 1981 GDP was only $3 trillion, growing by five times to $15 trillion in 2012. See the table below for a year-by-year detail of each President's budget deficit since President Woodrow Wilson. (Updated September 12, 2012) Budget Deficits by Fiscal Year Since 1960:
Here's What the Senate's 'Fiscal Cliff' Deal Looks Like
The U.S. Senate was expected to vote early on Tuesday on a deal to avert $600 billion in automatic tax increases and spending cuts in the "fiscal cliff" that could hobble the economy if allowed to take effect this week. If this alternative to the fiscal cliff passes the Senate, the House of Representatives could also vote on the measure later on Tuesday. Here are details of the deal, according to congressional sources: * Postpones for two months the start of $1.2 trillion in automatic spending cuts over 10 years, known as the "sequester." For those two months, $24 billion in savings would be substituted. Half of those savings would be split between defense and non-defense programs. The other half includes new revenues.
* Raises $600 billion in revenue over 10 years through a series of tax increases on wealthier Americans. * Permanently extends tax cuts made in 2001 by Republican President George W. Bush for income below $400,000 per individual, or $450,000 per family. Income above that level would be taxed at 39.6 percent, up from the current top rate of 35 percent. * Above that income threshold, capital gains and dividend tax rates would return to 20 percent from 15 percent. * Caps personal exemptions and itemized deductions for income above $250,000, or $300,000 per household. * Raises estate tax rate to 40 percent for estates of more than $10 million per couple, up from the current level of 35 percent. * Includes a permanent fix for the alternative minimum tax. * Extends unemployment insurance benefits for one year for 2 million people. * Extends child tax credit, earned income tax credit, and tuition tax credit for five years. * Extends research and experimentation tax credit, and the wind production tax credit through the end of 2013. Extends 50 percent bonus depreciation for one year. * Avoids a cut in payments to doctors treating patients on Medicare - the so-called "doc fix." * Temporarily extends farm programs. * Cancels a cost-of-living raise for members of Congress.
self-inflicted burden on the economy and financial markets. What's more, the agreement addressed only the revenue side (taxes) but postponed any discussion of spending cuts for another two months. Also, it's important to keep in mind that higher taxes were the most important element of the cliff, and taxes are in fact going up as part of the deal. While the problem is therefore "solved" in the sense that the debate is over, a portion of the concerns related to the cliff indeed came to fruition. And on a longer-term basis, the cliff deal did little to address the country's debt load - which currently stands at $16.4 trillion and counting. The 2012 Fiscal Cliff Debate In dealing with the fiscal cliff, U.S. lawmakers had a choice among three options, none of which were particularly attractive:
They could have let the policies scheduled for the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – go into effect. The plus side: the deficit would have fallen significantly under the new set of laws.
They could have cancelled some or all of the scheduled tax increases and spending cuts, which would have added to the deficit and increased the odds that the United States would face a crisis similar to that which is occurring in Europe. The flip side of this, of course, is that the United States' debt would have continued to grow. They could have taken a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth. This is ultimately the course lawmakers choice in the agreement reached on December 31, 2012.
The fiscal cliff was a concern for investors and business since the highly partisan nature of the political environment made a compromise difficult to reach. Lawmakers had well over a year to address this issue, but Congress – mired in political gridlock – put off the search for a solution until the eleventh hour, rather than seeking to solve the problem directly. In general, Republicans wanted to cut spending and avoid raising taxes, while Democrats sought a combination of spending cuts and tax increases. The agreement currently on the table raises tax rates to 39.6% from 35% on individual with income of more than $400,000 and on couples with incomes of more htan $450,000. It also lets the 2% payroll tax cut expire and delays spending cuts for another two months. The likely outcome of these changes is that economic growth will be pressured modestly, but the country will not face the severe economic downturn it would have if all of the laws related to the fiscal cliff had gone into effect. The Worst-Case Scenario If the current laws slated for 2013 had become law, the impact on the economy would be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the CBO also estimated that the policy would have reduced gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession (i.e., negative growth). At the same time, it predicted that unemployment would rise by almost a full percentage point, with a loss of about two million jobs. A Wall St. Journal article from May 16, 2012 estimated the following impact in dollar terms: “In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sunsetting of the Bush tax cuts; $125 billion from the expiration of the Obama payroll-tax holiday; $40 billion from the expiration of emergency unemployment benefits;
and $98 billion from Budget Control Act spending cuts. In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that.” Amid an already-fragile recovery and elevated unemployment, the economy was not in a position to avoid this type of shock. The Term "Cliff" is Misleading It's important to keep in mind that while the term “cliff” indicated an immediate disaster at the beginning of 2013, this wasn't a binary (two-outcome) event that would have ended in either a full solution or a total failure on December 31. There were two important reasons why this is the case: 1) If all of the laws went into effect as scheduled and stayed in effect, the result would undoubtedly be a return to recession. However, the chances that such a deal wouldn't be reached were slim despite the length of time it took to come to an agreement. 2) Even if the deal did not occur before December 31, Congress had the options to change the scheduled laws retroactively to January 1 after the deadline. With this as background, it's important to keep in mind that the concept of "going over the cliff" was largely a media creation, since even a failure to reach a deal by December 31 never ensured that a recession and financial market crash would occur. The Next Crisis Unfortunately, the fiscal cliff isn't the only problem facing the United States right now. At some point in the first quarter, the country will again hit the "debt ceiling" - the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff. To learn more about this issue, see my article What is the Debt Ceiling? A Simple Explanation of the Debate and Crisis. Learn more: Fiscal Cliff Definition: The fiscal cliff is a combination of four tax increases and two spending cuts that are scheduled to automatically take place on January 1, 2013. The tax increases occur when the Bush tax cuts, the 2% payroll tax holiday and the extension of the alternative minimum tax waiver all expire on December 31,
2012. When the Bush tax cuts expires, the tax rates will increase as follows: Income taxes: revert toClinton-era rates. Capital gains tax: from 15% to 20%. Dividend taxes: from 15% to more than 43%.
Estate taxes: from 35% to 55%, depending on the size of the estate. Investors also avoided a potential 3.8% hike on capital gains and dividends as a result of Obamacare taxes.(Source: CNBC, Wealthy Dump Assets, November 12, 2012)
The expiration of the payroll tax cut means workers will see an additional 2% taken out of the paycheck to go toward Social Security. Without a waiver, the alternative minimum tax will apply to 21 million more workers, making as little as $50,000 a year.
The next day, the Obamacare taxes kick in. This is additional income and investment taxes on family incomes above $250,000. The spending cuts occur when the extended unemployment benefits expire and an across-the-board 10% Federal budget cut kicks in. It's called a fiscal cliff because Federal taxes and spending are managed by fiscal policy. It's a cliff because the effect of increased taxes and decreased spending happening at once is like pushing the economy off a cliff. The term was coined by Federal Reserve Chairman Ben Bernanke in February 2012 when he warned the House Financial Services Committee,"Under current law, on Jan. 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases..." (Source: The Hill,Bernanke Warns of Massive Fiscal Cliff, February 29, 2012) However, the term "fiscal cliff" has been in use since 1987, when the Boston Globe used it to describe a local utility's financial situation. It was used again in 1991 by California Representative Henry Waxman, referring to Oregon's budget. (Source: Oxford Dictionary) Fiscal Cliff 2012: The fiscal cliff negotiations became a critical issue after the 2012 Presidential election. First President Obama developed a plan A, then House Speaker Boehner responded with a Plan B. Uncertainty around the outcome kept economic growth lower than needed to reduce unemployment. That's because most businesses had to be conservative, and follow operational plans that included the fiscal cliff scenario. For more, see Fiscal Cliff 2012. Fiscal Cliff 2013: What happens in 2013 if nothing is done? Here's some of the major changes: On average, taxes will go up $2,000 to $3,000 per household. Around 26 million taxpayers will become eligible to pay the Alternative Minimum tax, originally set up to capture wealthy tax dodgers. However, since it wasn't indexed for inflation, it will raise taxes for many middle income taxpayers by as much as $3,700.
Roughly two million jobseekers will lose extended unemployment benefits. There will be a $55 billion cut in military spending, resulting in temporary job losses. Most other departments will be cut 8%. This includes aid to states, highway construction and the FBI. (Source: CNBC, Cliff Plunge: All But Impossible to Avoid the Pain, November 13, 2012; Forbes, The Fiscal Cliff Explained,
November 10, 2012) To make matters worse, Federal spending is likely to exceed the debt ceiling, currently at $16.394 trillion, early in 2013. If Congress doesn't raise the ceiling, the nation will go into adebt default. President Obama tried to make raising the debt ceiling part of the fiscal cliff negotiations. For updates, see Fiscal Cliff 2013. How the Fiscal Cliff Affects the Economy: The tax hikes and spending cuts would remove $607 billion from the economy in the first nine months of 2013 (that's the remainder of the 2013 Fiscal Year), according to the Congressional Budget Office. Although it's good long-term to reduce the deficit, in the short term it will severely retard economic growth. That's because government spending is an important component of the Gross Domestic Product (GDP). Suddenly cutting it by 10% or so would mean broken contracts with businesses, fewer government jobs and reductions in benefits.
The tax increases would reduce consumer spending by that amount. The net effect, according to the CBO, would be a 1.3% contraction in the economy for the first half of the year. In other words, a recession. Although the economy would recover in
the second half, the growth would be anemic -- barely 2%, or the low end of a healthy economy. Most legislators agree that this can't be allowed to happen. How the Fiscal Cliff Affects You: The fiscal cliff has already affected you by slowing economic growth. As a result of the impending uncertainty, businesses have postponed hiring and expansion. This makes it harder for the unemployed to find a good job.
In 2013, if nothing is done, the economy will go back into recession. That means you might lose your job, especially if you just got it, as businesses tend to lay off the most recently hired first.
The fiscal cliff will impact some more than others. The long-term unemployed will lose their extended benefits. Everyone will have to pay more in payroll and income taxes. Those dependent on government contracts may lose the Federal government as a customer, while Federal employees may get laid off. What Caused the Fiscal Cliff?: In 2011, the President and a Democrat-controlled Senate disagreed with the Republican-controlled House on the the best ways to reduce the deficit and debt. As government spending approached the debt ceiling, both parties finally agreed to appoint a bipartisan commission to propose a solution. The subsequent Simpson-Bowles Report was, unfortunately, ignored. Instead, Congress passed the Budget Control Act, which mandated a 10% spending cut. This was intended to be so severe that it would force Congress to act.
The impasse was basically in three main areas:
1. 2. 3.
The Democrats refused to extend the Bush tax cuts for families making $250,000 or more. The Republicans refused to extend the tax cuts for anyone if everyone can't have them. The Democrats would rather cut more out of defense spending, while the Republicans would rather cut Social Security, Medicaid and Medicare. In addition, the Republicans want to repeal the Obamacare taxes.
This standoff was a little bit of political posturing in advance of the 2012 Presidential election. With that behind us, it looks more hopeful that both parties will find enough of a common ground to avoid falling off the fiscal cliff and plunging the economy into recession.Article
US Fiscal Cliff 2013
n New Year's Day, the House approved a Senate bill that averted the fiscal cliff. Republicans were unhappy that there weren't more spending cuts, but at least an income tax hike was averted for most Americans.
Here's what the new bill contained:
1. 2. 3.
Bush tax cuts were kept on incomes below the threshold ($400,000 for individuials, $450,000 for married couples). Incomes at and above the threshold will now be taxed at 39.6%. Capital gains and dividends taxes were raised from 15% to 20% for families at the threshold and above. Estate taxes were raised to 40% of estates above $5 million for those at and above the threshold. The 2% payroll tax credit was allowed to expire.
4. 5. 6.
The income level at which the alternative minimum tax kicks in was permanently raised, so it doesn't affect middleincome taxpayers. It is indexed for inflation, so that it doesn't have to be patched year after year. The extended unemployment benefits will continue for a year. Sequestration has been postponed for two months. The spending cuts that Republicans want will be part of the normal FY 2014 budget negotiations -- as they should be.
Other Provisions of the Bill Some exemptions and deductions were extended, such as the mortgage insurance premium (through 2013), the American Opportunity Tax Credit (through 2017) and the Earned Income Tax Credit (permanently). Others will be limited on incomes above $250,000 ($300,000 for married couples. For details on these, see House Approves Taxpayer Relief Act.
The bill takes action on other important points:
It prevents a 37% decline in Medicare payments to doctors. It extends federal dairy subsidies through the end of FY 2013. This prevents a hike in milk prices. It does not include a .5% pay raise for Congress proposed by President Obama.
Like most other legislation, the bill contained some last-minute riders to provide a hodge-podge of smaller tax exemptions for special interest groups. These range from tax breaks for NASCAR, Hollywood, and AMTRAK. For more, see Wonkblog, 10 Wierdest Parts of the Fiscal Cliff Deal. What Made the Vote Possible: We actually fell off the fiscal cliff for barely 24 hours. Since all Bush tax cuts expired, Tea PartyRepublicans can't be accused of raising taxes. Instead, they reinstated the tax cuts for incomes at $400,000 or less, and then instituted a smaller tax cut for incomes above that amount. Congress wanted to vote on the measure before newly elected members took office on Thursday. This shifted the voting power more toward the Democrats, even though the House retained a Republican majority. For more, see House Approves Fiscal Cliff Bill -- What It Means to You. The Disaster That Was Averted: The fiscal cliff refers to the devastating impact on the economy in 2013 if national leaders allowed four tax increases and two spending cuts to take place at the beginning of the year. According to the Congressional Budget Office, $607 billion in government stimulus would have been removed from U.S. Gross Domestic Product (GDP) between January and September 2013 (These dates correspond to the last nine months of the 2013 Fiscal Year.) Two-thirds of that ($339 billion) would have resulted from the following tax increases: 1. Expiration of Bush tax cuts and the ARRA - $229 billion. 2. Expiration of the 2% payroll tax holiday, part of the Obama tax cuts, - $95 billion. 3. 4. Expiration of partial expensing of investment properties - $65 billion. Obamacare tax increases - $18 billion.
The rest would have come from the following reductions in Federal spending: 1. Sequestration (automatic budget cuts) - $65 billion. 2. 3. Expiration of extended unemployment benefits - $26 billion. Reduction in Medicare payments to doctors - $11 billion.
Other, unspecified changes that reduced the deficit by another $105 billion.
Worst Case Scenario: There was never a real chance that nothing would be done, the worst case scenario. No elected official wanted to be responsible for allowing a recession. That's what the Congressional Budget Office (CBO) predicted, saying the economy would contract 1.3% for the first two quarters of 2013. Even though the CBO projected that the economy would recover, growing 2.3% in the second half of the year, it would have caused more unemployment while only reducing the deficit by $560 billion. That's because people who have been laid off pay less in taxes, translating to lower revenue for the government. Best Case Scenario: The best case scenario would have been if Congress extended all tax cuts and kept spending at current levels. In that case, the economy would have grow 4.4% in 2013 according to the CBO. At that growth rate, job creation would rise and the unemployment rate would drop. That would pretty much eliminate the need for extended unemployment benefits, as they are tied to aboveaverage state unemployment rates. More income from wages means that tax revenue would rise, reducing the deficit and debt. A healthy economy can grow its way out of a high debt-to-GDP ratio. The higher the GDP, the lower the ratio -- as long as spending doesn't increase. For proof, notice that the national debt by year keeps increasing. Even though the debt from World War II has never been paid off, it doesn't matter. Economic growth has since dwarfed it. However, it's highly unlikely that Congress would support this scenario. Way too many elected officials think that the Federal debt is unsustainable at even a 90% debt-to-GDP ratio. (Source: CBO, Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013, May 2012) Article updated January 3, 2013
The Fiscal Cliff and its Impact on Small Business
November 12, 2012 Even before President Obama was re-elected, there were discussions about the "fiscal cliff" that exists at the end of 2012 and the danger of the U.S. falling off this fiscal cliff. What is the fiscal cliff and how does it impact small businesses? The fiscal cliff is the term used for the man-made, or politican-made, problem that has resulted because of the inability of the Congress and the President to work together during President Obama's first term in office. As a result of that stalemate, there are a number of significant financial events taking place at the end of the year that, together, could constitute a severe economic contraction and a drop in our gross domestic productduring 2013. When the politicians, over the last few years, could not reach an agreement about one issue or another, they just kept putting off the decisions or "kicking the can down the road." None of the big problems ever got solved. The fiscal cliff resulted when the deadline for all these problems is happening at once at the end of 2012. These financial problems are a series of tax hikes and spending cuts by the federal government that will happen unless the federal government takes some sort of action by 12/31/2012. This is called thefiscal cliff. The Congressional Budget Office projects that around $800 billion in tax hikes and spending cuts will happen in 2013 if the decisions the politicians refused to make go unmade again this year. What Composes the Fiscal Cliff?
Bush Tax Cuts: The Bush tax cuts will expire on 12/31/2012. President Obama wants to renew the Bush tax cuts for everyone who makes under $250,000. The Republican Housewants to renew the Bush tax cuts for everyone including those who make more than $250,000. This is going to be one of the arguments over the fiscal cliff. The first Bush tax cut, in 2001, was enacted to stimulate the economy during the 2001 recession. The second Bush tax cut increased tax deductions for small businesses and lowered the capital gains tax from 20% to 15%. Never did anyone imagine that these tax cuts would become such a political hot potato so many years later. Most think tanks and economists think that dropping the Bush tax cuts for those with incomes over $250,000 will not substantially hurt small business. A Treasury Department study found that only 2.5% of small businesses are in the tax brackets with incomes above $250,000. The claims that allowing the Bush tax cuts for the top tax brackets to expire would negatively affect small business are misleading. There are other provisions in the Bush tax cuts that affect primarily individuals and might affect some small businesses. These provisions include the expiration of tax cuts on income, investments, the married couples benefit, tax provisions for families with children, and protection for inheritances. In addition to the Bush era tax cuts that will be lost, other issues on the table that comprise the fiscal cliff are the expiration of unemployment benefits for the long-term jobless, a large reduction in reimbursements to doctors participating in Medicare, the imposition of the alternative minimum tax on 26 million additional households, the expiration of President Obama's 2% payroll tax holiday, and a number of smaller cuts for households and businesses. Automatic Spending Cuts: Last year, Congress failed to reach any sort of bipartisan agreement on debt-reduction. As a result, the Budget Control Act was passed. The provisions of this Act requires that automatic spending cuts begin on January 2, 2013 that will reduce the deficit by $1.2 trillion over 10 years. Just the 2013 portion of the spending cuts will take a deep chunk of money out of the economy. Discretionary defense spending will sustain a deep cut of $55 billion in 2013. Nondefense spending will also be cut by $55 spending including programs like education. What can be Done to Avert a Crisis? This situation is quite serious and is the results of complications of a political impasse between Congress and the White House between about 2013 and the present day. One can think back to the beginning of the first term of the President in 2008 and remember that Kentucky Senator, Mitch McConnell stated that his entire mission for the next four years was to make sure that Obama was a one-term President. With thinking like that on Capitol Hill, no wonder nothing can be accomplished - and now look where it has gotten us. Not only do Congress and the President have to find a way to compromise by the end of the year for the good of the American people, but they also have to do this for the credit rating of the U.S. Government. When the U.S. Congress and White House had such a bitter fight over the debt ceiling in 2011, Standard and Poor's downgraded our debt from AAA to AA+. However, there are three credit reporting agencies. Now, both Fitch and Moody's credit reporting agencies have said that failure to reach a bipartisan compromise on a debt-reduction plan by the end of the year will cause them to lower the U.S. credit rating as well.
What is likely to happen is another hard-fought compromise that moves us forward very little. The politicians can cancel some or all of the tax hikes and spending cuts which would greatly increase the debt of the U.S. and throw us into a debt crisis approaching the one facing Europe. On the other end of the spectrum, they could let the tax hikes and spending cuts go into effect. The deficit would be cut substantially but the average American family would be hurt as well as American businesses. A middle of the road compromise, if our politicians can compromise, is available. It is hard to know what the middle of the road approach would look like but it would probably involve some combination of keeping part of the Bush tax cuts and either stopping the automatic spending cuts or substantially cutting them back. What I see in the President's future is the absolute necessity to find a way to compromise with the Republican House, not just on the fiscal cliff but on everything that comes afterward. The President and the Congress have a big, difficult job ahead. If you have solid opinions on these issues, write your Congressman. One of the other About.com Websites has great information about how to go about doing that. Check it out here.
U.S. National Debt Clock
hat Is the U.S. National Debt Clock?: The national debt clock tracks the U.S. debt. It's located on West 44th Street and Avenue of the Americas in New York. It was conceived by Seymour Durst, who put the first national debt clock up at Sixth Avenue and 42nd Street on February 20, 1989, when the national debt was nearing $2.7 trillion and 50% of GDP. Durst said, “If it bothers people, then it's working.” The debt clock faithfully recorded the increasing U.S. debt until 2000, when the prosperity of the 1990s created enough revenue to reduce the federal budget deficit and debt. It seemed as if the debt clock had done its job. The Debt Clock Tracks the Growing U.S. Debt: Unfortunately, that prosperity didn’t last. The 2001recession and the 9/11 terrorist attacks meant lower revenues, higher spending and more deficits to add to the debt. The clock was reactivated in July 2002, and then moved in 2004. When the debt exceeded $10 trillion in September 2008, one more digit was added. It took 13 years for the debt to double. By 2002, it had grown to $6 trillion, but only 46% of GDP, around $45,000 per household. It only took eight years to double again. The $700 billion bailout and raised it to $12 trillion in 2010, which was 85% of GDP and $86,000 per household.
The debt reached a new record on August 31, 2012. That's when it reached $16 trillion. This made the debt bigger than annual economic output, as measured by Gross Domestic Product, which was $15.6 trillion as of the second quarter of 2012. In addition to installing the clock, Durst bought ads on the front page of the New York Times. His May 26, 1991 message was prophetic: "Federal debt soaring, national economy shrinking, soon the twain shall meet." (Source: Times Magazine, The Times Square Debt Clock, October 14, 2008)
How much is the debt now? You don't need to fly to New York and see the debt clock to find out. Simply go to the U.S. Treasury web site: Debt to the Penny. Why Is the U.S Debt Clock Important?:
The debt clock shows how much the U.S. government owes its citizens, other countries and itself. Since 79% of its revenue comes from individual taxes, that means it is counting on you to pay it back one day. And, since corporations can pass their tax costs through to you by raising prices, this means that essentially 100% of the debt must be paid by you, your children or your grandchildren through higher taxes. Uncertainty about when taxes will be raised dampens expectations of future economic growth. This threatens to lower the quality of life for future generations. Second, increasing debt means the government is becoming more involved in your life through the programs the debt is paying for. Third, since much of the debt is financed by loans from foreign governments, they now have a voice in what happens in the U.S. Fourth, as the debt approaches the debt ceiling, politicians must vote to raise the ceiling. If the vote fails, as the Greek government did in early 2010, the U.S. could be plunged into crisis. In short, the higher the debt, the greater the risk of fiscal crisis. By watching the national debt clock, you will be aware of this risk, and how much you ultimately owe. Why the Debt Keeps Growing:
The debt is an accumulation of budget deficits. Year after year, the government cut taxes and increased spending. In the short run, the economy and voters benefited from deficit spending. Furthermore, foreign debt holders like China and Japan, allow the U.S. to run a large tab because it's such a good customer. They haven't demanded the higher interest payments that usually keeps government debt in check. How Is the Debt Financed?: The U.S. national debt is the sum of all outstanding debt owed by the Federal Government. Nearly two-thirds is the public debt, which is owed to the people, businesses and foreign governments who bought Treasury bills, notes and bonds. The rest is owed by the government to itself. Most of this is owed to Social Security and other trust funds, which were running surpluses. These securities are a promise to repay these funds when Baby Boomers retire over the next 20 years. (Source: U.S. Treasury, Debt FAQ) The Debt Clock Warning: Two factors that allowed the U.S. debt to grow are now being withdrawn. First, the Social Security Trust Fund took in more revenue through payroll taxes leveraged on Baby Boomers than it needed. Ideally, this money should have been invested to be available when the Boomers retire. In reality, the Fund was "loaned" to the government to finance increased deficit spending. This interest-free loan helped keep Treasury Bond interest rates low, allowing more debt financing. However, it's not really a loan, since it can only be repaid by increased taxes when the Boomers do retire. Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore, this lessening of demand is putting downward pressure on the dollar. That's because dollars, and dollar denominated Treasury Securities, are becoming less desirable, so their value declines. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand. How the Federal Debt and Deficit Are Different: The U.S. Federal Deficit is when government spending is greater than revenue received for that year. In Fiscal Year 2011, the budget deficit was projected to be $1.267 trillion. The FY 2010 deficit was $1.57 trillion.
By the end of 2011, the U.S. Federal Debt was more than $15 trillion. This is more than double the debt in 2000, which was $6 trillion. How Does the Deficit Affect the Debt?: Each year, the deficit is added to the debt. The Treasury must sell Treasury bonds to raise the money to cover the deficit. This is known as the public debt, since these bonds are sold to the public. In addition to the public debt, there is the money that the government loans to itself each year. This money is in the form of Government AccountSecurities, and it comes from the Social Security Trust Fund. These loans are not counted as part of the deficit, since they are all within the government. However, as the Baby Boomers retire, they will begin to draw down more Social Security funds than are replaced with payroll taxes. These benefits will need to be paid out of the general fund. This means that either other programs must be cut, taxes must be raised or benefits must be lowered. Unfortunately, legislators have not yet agreed on an effective plan to meet Social Security obligations. How Does the Debt Affect the Deficit?: The debt affects the deficit in three ways. First, the debt actually gives a better indication of the true deficit each year. You can more accurately gauge the deficit by comparing each year's debt to last year's debt. That's because the budget deficit, as reported in each year's budget, does not include the amount owed to the Social Security Fund. However, this is a debt that will need to be repaid one day, and so the amount borrowed from it is a more accurate description of each year's government liabilities than the reported budget deficit. (Source: St. Louise Federal Reserve, Deficit, Debts and Trust Funds, August 2006) Second, the interest on the debt is added to the deficit each year. About 5% of the budget is allocated to debt interest payments. Interest on the debt hit a new record in FY 2011, reaching $454 billion. This beat its prior record of $451 billion in FY 2008 -- despite lowerinterest rates. By 2020, the interest payment is projected to quadruple to $840 billion, making it the fourth largest budget item. (See Budget Spending) Third, the debt can decrease tax revenue, thereby further increasing the deficit. As the debt continues to grow, creditors can become concerned about how the U.S. government plans to repay it. Over time, these creditors will expect higher interest payments to provide a greater return for their increased perceived risk. Higher interest costs dampen economic growth. How Does the Deficit and Debt Affect the Economy?: Initially, deficit spending and the resultant debt can increase economic growth. This is especially true in arecession. That's because deficit spending pumpsliquidity into the economy. Whether the money goes to jet fighters, bridges or education, it ramps up production and creates jobs. However, not every dollar creates the same number of jobs. In fact,military spending creates 8,555 jobs for every billion dollars spent. This is less than half the jobs created by that same billion spent on construction. For more, see Unemployment Solutions. In the long run, the resultant debt is very damaging to the economy, and not only because of higher interest rates. The U.S. government may be tempted to let the value of the dollar fall so that the debt repayment will be in cheaper dollars, and less expensive. As this happens, foreign governments and investors will be less willing to buy Treasury bonds, forcing interest rates even higher. The greatest danger comes from the debt to Social Security. As this debt comes due when Baby Boomers retire, funds will need to found to pay them. Not only could taxes be raised, which would
slow the economy, but the loan from the Social Security Trust Fund will stop. More and more of the government's spending will need to be devoted to pay this mandatory cost. This would provide less stimulation, and could further slow the economy. (Article updated January 2, 2012)
U.S. Debt by President
What's the best way to determine how much of the $16 trillion U.S. debt is attributable to each President? The most popular way is tolook at the debt level when each President took office. Sometimes it's easier to look at a graph showing the percent of the debtaccumulated under each President. It's also important to compare the debt as a percent of economic output. However, these aren't the most accurate ways to measure the debt contributed by each President. Why? The President doesn't really have much control over debt accumulation during his first year. That's because the budget for that fiscal year was already set by the previous President. The new President pretty much has to live with that budget's tax rates and spending levels for the first nine months of his inaugural calendar year in office. You really can't hold him accountable for the debt incurred by the previous President's budget. In rare cases, a President can add an amendment to that budget, but must first get Congressional approval. For example, President Obama inherited President Bush's FY 2009 budget. In March 2009, he got Congress to pass the Economic Stimulus Act. This added a year's worth of stimulus spending to the FY 2009 budget. The Best Way to Measure Debt by President:
Therefore, the most accurate way to measure the debt by President is to sum all the budget deficits. That's because the President is responsible for his budget priorities. It takes into account spending, and anticipated revenue from proposed tax cuts or hikes.
There are a few caveats, however. First, Congress does have a role, since it must approve the budget. Second, each President inherits a previous President's policies. For example, every President has had to compensate for lower revenue thanks to President Reagan's tax cuts. That's because tax increases are a sure way to prevent re-election.
Third, while every President has had to deal with a recession, all recessions were not created equal. Furthermore, some Presidents have had to deal with unusual events, like the 9/11 terrorist attack and Hurricane Katrina. While these weren't part of the business cycle, they required responses that came with economic price tags. President Barack Obama: President Obama contributed the most to the debt, with cumulative deficits totaling $5.073 trillion in just four years. Obama's budgets included the economic stimulus package, which added $787 billion by cutting taxes, extending unemployment benefits, and funding job-creating public works projects. The Obama tax cuts added $858 billion to the debt over two years. Obama's budget included increased defense spending to around $800 billion a year. Federal income was down, thanks to lower tax receipts from the 2008 financial crisis. Both Presidents Bush and Obama had to contend with higher mandatory mandatory spending forSocial Security and Medicare. He also sponsored thePatient Protection and Affordable Care Act, which was designed to reduce the debt by $143 billion over 10 years. However, these savings didn't show up until the later years. President George W. Bush: President Bush is next, racking up $3.294 trillion over two terms. He responded to the attacks on 9/11 by launching the War on Terror. This drove military spending to a new records, between $600-
$800 billion a year. President Bush also responded to the 2001 recession by passing EGTRRA and JGTRRA, otherwise known as the Bush tax cuts. President Ronald Reagan: President Reagan added $1.412 trillion to the debt during his two terms. He fought the 1982 recession by cutting the top income tax rate from 70% to 28%, and the corporate rate from 48% to 34%. He also increased government spending by 2.5% a year. This included a 35% increase in the defense budget, and an expansion of Medicare. Although $1.412 trillion doesn't sound like a lot, compared to 2012 debt levels, in fact Reagan's economic policiesdoubled the debt during his Presidency. President George H.W. Bush: President George H.W. Bush added $1.03 trillion to the debt in one term. He responded to Iraq's invasion of Kuwait with Desert Storm. He oversaw the $125 billion bailout to end the1989 Savings and Loan crisis. Part of his debt contribution was due to lost tax revenue from the 1991 recession. Although many other Presidents added to the debt, none comes close to these four in terms of overall spending. Part of that is because the U.S. economy, as measured by GDP, was so much smaller for other Presidents. For example, in 1981 GDP was only $3 trillion, growing by five times to $15 trillion in 2012. See the table below for a year-by-year detail of each President's budget deficit since President Woodrow Wilson. (Updated September 12, 2012) Budget Deficits by Fiscal Year Since 1960:
Here's What the Senate's 'Fiscal Cliff' Deal Looks Like
The U.S. Senate was expected to vote early on Tuesday on a deal to avert $600 billion in automatic tax increases and spending cuts in the "fiscal cliff" that could hobble the economy if allowed to take effect this week. If this alternative to the fiscal cliff passes the Senate, the House of Representatives could also vote on the measure later on Tuesday. Here are details of the deal, according to congressional sources: * Postpones for two months the start of $1.2 trillion in automatic spending cuts over 10 years, known as the "sequester." For those two months, $24 billion in savings would be substituted. Half of those savings would be split between defense and non-defense programs. The other half includes new revenues.
* Raises $600 billion in revenue over 10 years through a series of tax increases on wealthier Americans. * Permanently extends tax cuts made in 2001 by Republican President George W. Bush for income below $400,000 per individual, or $450,000 per family. Income above that level would be taxed at 39.6 percent, up from the current top rate of 35 percent. * Above that income threshold, capital gains and dividend tax rates would return to 20 percent from 15 percent. * Caps personal exemptions and itemized deductions for income above $250,000, or $300,000 per household. * Raises estate tax rate to 40 percent for estates of more than $10 million per couple, up from the current level of 35 percent. * Includes a permanent fix for the alternative minimum tax. * Extends unemployment insurance benefits for one year for 2 million people. * Extends child tax credit, earned income tax credit, and tuition tax credit for five years. * Extends research and experimentation tax credit, and the wind production tax credit through the end of 2013. Extends 50 percent bonus depreciation for one year. * Avoids a cut in payments to doctors treating patients on Medicare - the so-called "doc fix." * Temporarily extends farm programs. * Cancels a cost-of-living raise for members of Congress.
