The Fiscal Cliff: The Perspectives of a Second Dive

The Fiscal Cliff: The Perspectives of a Second Dive
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After the 2011 summer political debacle to raise the ceiling of the US debt, another potential risk is looming for the end of 2012. Last year’s debate led to the first downgrade of the credit rating of US government bonds in history by the credit-rating agency Standard & Poor’s.

The credit rating company said “political brinkmanship” in the debate over the debt had made the U.S. government’s ability to manage its finances “less stable, less effective and less predictable.” It said the bipartisan agreement reached, at the very end of the deadline, to find at least $2.1 trillion in budget savings “fell short” of what was necessary to tame the nation’s debt over time and predicted that leaders would not be likely to achieve more savings in the future.

The battle between the GOP and democrats was around the raise of the debt ceiling as requested by the democrats or the downsize of different federal programs as requested by the GOP. Interestingly the best example of the total disconnection of this debate with the reality is the following graphic. Between 2001 and 2008, the US public debt raised from 18% to 24% of the GDP while the revenues fell from 20% to nearly 15% of the GDP. In this context, one may question why would the GOP suddenly require a drastic change in a policy followed by the former GOP administration. One would argue that the economic crisis, requires budget spending priorities and potential cuts. What is though more questionable is the obstinacy with which the GOP refused to compromise with the democrats until the very last moment. Widely perceived as a political move intended to weaken the President, the Congress Status Quo has only reinforced the idea of a counter productive Congress (ie. Washington), unable to fix the economy. A year later, a similar scenario is set for replay in the coming months, as several tax cuts expire by the end of the year.

According to CBS News: “Monday marks the first day of the federal government’s new fiscal year, but there is not much to celebrate because we are headed toward what’s being called a fiscal cliff. There were dire new warnings Monday about what will happen to American families unless Congress and the president reach a budget deal by December 31. That is the day that several tax cuts will expire, and big cuts in federal spending will take hold.

Tax experts said 90 percent of American families are facing what they will call “unprecedented tax increases.” According to the non-partisan Tax Policy Center, the U.S. is on the threshold of one of the largest tax increases in history, a tax hike that could average $3,500 for every American household.

“The increases are so large because the nation’s biggest tax cuts all expire three months from now on New Year’s Day. They include the Bush-era federal income tax cuts, the payroll tax cut that lowered Social Security and Medicare taxes, and several remaining stimulus tax cuts. They all go away January 1 unless Congress and the president reach a deal on the budget.”


“Many economists are concerned that a tax increase of that size will shock the economy and trigger a recession by reducing the cash taxpayers have to spend. But now, Congress and the president have a firm price tag on what it costs if they don’t reach a budget deal after the election.”

Now what strategy both parties will adopt will largely depend on the outcome of the next presidential elections in November.

In the video above, CBS News asked Christine Lagarde, managing director of the International Monetary Fund, why the world economy has been slowing for the last several months. Mrs Lagarde also commented on the Fiscal Cliff risks.

Financial markets and corporations hate uncertainty. Do we really need to add another factor of financial uncertainty to the lingering European financial crisis which is already weighing on the US and global economy?

Another rating agency, Moody’s, issued the 11th of September 2012 the following explicit statement:

Update of the Outlook for the US Government’s Debt Rating

The US government bond rating remains unchanged at Aaa with a negative outlook. The direction of the US rating and its outlook will most likely be determined by the outcome of budget negotiations during the course of 2013. In particular:

» If those negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable.

» If those negotiations fail to produce a plan that includes such policies, we would expect to lower the rating, probably to Aa1.

Sources: CBS Evening News / Tax Policy Center / Wikipedia
Photo Credits: Rep. Robert Dold, Jr., R-Ill  9:30 am  Rep. Robert Dold, Jr., R-Ill.; Rep. Charlie Bass, R-N.H.; Rep. Steven LaTourette, R-Ohio; and Rep. Daniel Lipinski, D-Ill. hold a news conference to call on Congress to work together to address the looming “fiscal cliff.”  LOCATION: House Triangle, U.S. Capitol / FlickR