The Budget Control Act of 2011 was enacted due to the failure of the 111th Congress to pass a Federal Budget and therefore as a compromise to resolve a dispute concerning the public debt ceiling. Deficit spending previously appropriated by Congress was bringing the federal government's total debt close to the statutory ceiling. Republicans in Congress refused to approve an increase in the ceiling unless there were deep spending cuts in order to come closer to a balanced budget and reduce the amount of national debt that was accruing. The Budget Control Act included an immediate increase in the debt ceiling, along with a mechanism for facilitating two additional increases. It also provided for automatic spending cuts to begin on January 2, 2013.
The year-over-year changes for fiscal years 2012?2013 include a 19.63% increase in tax revenue and 0.25% reduction in spending. These changes would return tax revenue to approximately its historical average of 18% GDP, while continuing to spend at dollar levels held approximately the same since 2009. Some major programs, like Social Security, Medicaid, federal pay (including military pay and pensions), and veterans' benefits, are exempted from the spending cuts. Spending for federal agencies and cabinet departments would be reduced through broad, shallow cuts referred to as budget sequestration.
The projected effects of these changes have led to calls both inside and outside of Congress to extend some or all of the tax cuts, and to replace the across-the-board reductions with more targeted cutbacks. It has been speculated that any change is unlikely to come until the period roughly between the 2012 federal elections and the end of the year. Additionally, the debate may be exacerbated by the expectation that the debt ceiling is expected to be reached before the end of 2012, unless "extraordinary measures" are used. Nearly all proposals to avoid the fiscal cliff involve extending certain parts of the 2010 Tax Relief Act or changing the 2011 Budget Control Act or both, thus making the deficit larger by reducing taxes and/or increasing spending.
Background
Etymology
The term fiscal cliff had in the past been used to refer to various fiscal issues. The term started being used in the current context near the original expiration of the Bush tax cuts in 2010. In 2011, the term started to be used to refer to the deficit reductions that would occur in 2013 under current law.In late February 2012, Ben Bernanke, chairman of the U.S. Federal Reserve, popularized the term "fiscal cliff" for this crisis. Before the House Financial Services Committee he described that "a massive fiscal cliff of large spending cuts and tax increases" would take place on January 1, 2013.
Some analysts have argued that fiscal slope or fiscal hill would be more appropriate terminology because while the cumulative economic effect over all of 2013 would be substantial, it would not be felt immediately but rather gradually as the weeks and months went by.
Legislative history
During a lame duck session in December 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The act extended the Bush tax cuts for an additional two years and "patched" the exemptions to the Alternative Minimum Tax (AMT) for tax year 2011. This act also authorized a one-year reduction in the Social Security (FICA) employee payroll tax. This was extended for an additional year by the Middle Class Tax Relief and Job Creation Act of 2012, which also extended federal unemployment benefits and the freeze on Medicare physician payments.On August 2, 2011, Congress passed the Budget Control Act of 2011 as part of an agreement to resolve the debt-ceiling crisis. The Act provided for a Joint Select Committee on Deficit Reduction (the "super committee") to produce legislation by late November that would decrease the deficit by $1.2 trillion over ten years. If the committee failed to do so, as it in fact had failed to do, another part of the Act directs automatic across-the-board cuts (known as "sequestrations"), split evenly between defense and domestic spending, beginning January 2, 2013. Also, the Affordable Care Act imposed new taxes on families making more than $250,000 a year ($200,000 for individuals) starting at the same time.
At the end of 2011, the patch to the AMT exemptions expired. Technically, the AMT thresholds immediately reverted to their 2000 tax year levels, a drop of 26% for single people and 40% for married couples. Anyone over these reduced thresholds at the end of 2012 would be subject to the AMT. Therefore, more taxpayers would pay more unless some legislation was passed (as was done in 2007) that affects the exemptions retroactively.
Key laws leading to the fiscal cliff
A number of laws led to the fiscal cliff, including these provisions:Expiration of measures delaying the Medicare Sustainable Growth Rate from going into effect (the "doc fix"), as extended by the Middle Class Tax Relief and Job Creation Act of 2012 (MCTRJCA);
Without new legislation, these provisions would automatically go into effect on January 1 or 2, 2013, except for the Alternative Minimum Tax growth, which would be changed retroactively. Some provisions would increase taxes (the expiration of the Bush and FICA payroll tax cuts and the new Affordable Care tax and AMT thresholds) while others would reduce spending (sequestration, expiration of unemployment benefits and implementation of the Medicare SGR).
Proposals to avoid the fiscal cliff involve repealing legislation containing certain of these provisions or passing new legislation to extend provisions that are due to expire. Different proposals may include changes to some or all of the above provisions. For example, the Congressional Budget Office's "Alternative Fiscal Scenario" includes only the first four items above. Changes to other provisions are also sometimes included in such proposals; for example, changing the original caps on discretionary appropriations contained in 2011's Budget Control Act, indexing the AMT exemptions for inflation or the wholesale or partial reform of the tax laws or entitlement programs.
Congressional Budget Office projections
CBO scenarios
Decisions regarding the fiscal cliff will have meaningful implications for deficits, debt, and economic growth. The Congressional Budget Office (CBO) has projected two fiscal scenarios for the years 2013 to 2022:The alternative fiscal scenario. Higher deficits and debt but lower taxes and higher spending.
These paint starkly different fiscal futures. If Congress and the President do not act, allowing tax cuts to expire and mandated spending cuts to be implemented, the next decade will more closely resemble the baseline projection. If they act to extend current policies, keeping lower tax rates in place and postponing or preventing the spending cuts, the next decade will more closely resemble the alternate fiscal scenario.
Baseline projection. The CBO has been publishing baseline projections since 1985. Under "the baseline", tax cuts are allowed to expire and spending cuts are implemented in 2013, resulting in higher tax revenues plus lower spending, deficits, debt and interest for the next decade and beyond. Future deficits would be reduced from an estimated 8.5% of GDP in 2011 to 1.2% by 2021. Revenues would rise towards 24% GDP, versus the historical average 18% GDP.
The total deficit reduction or debt avoidance over ten years could be as high as $7.1 trillion, versus the $10?11 trillion debt increases if current policies are extended. In other words, roughly 70% of debt increases projected over the next 10 years could be avoided by allowing laws on the books during 2012 to be implemented.
CBO estimates under the baseline projection that public debt rises from 69% GDP in 2011 to 84% by 2035. In the long run, lower deficits and debt should lead to relatively higher growth estimates. But, in the short run, real GDP growth in 2013 would likely be reduced to 0.5% from 1.1%. This would mean a high probability of recession (a 1.3% GDP contraction) during the first half of the year followed by 2.3% growth in the second half.
Alternate fiscal scenario. If Congress "avoids" the fiscal cliff, the future more closely resembles the continuation of 2012 policies, described by the CBO's "alternative fiscal scenario." This scenario involves extending the Bush income tax cuts, restricting the reach of the AMT, and keeping Medicare reimbursement rates at the current level (the so-called "doc fix", versus declining by one-third as mandated under current law). Revenues are assumed to remain around the historical average 18% GDP. Under this scenario, public debt rises from 69% GDP in 2011 to 100% by 2021 and approaches 190% by 2035. This scenario has considerably higher debt and interest payments than the baseline projection, but short-term impact on the economy is avoided.
Projected effects
The Congressional Budget Office estimates that allowing certain laws on the books during 2012 to expire or take effect in 2013 (the baseline scenario) would cut the 2013 deficit approximately in half and significantly reduce the trajectory of future deficits and debt increases for the next decade and beyond. However, the 2013 deficit reduction would adversely impact the economy in the short-run. On the other hand, if Congress acts to extend current policies (the alternative scenario), deficits and debt will rise rapidly over the next decade and beyond, slowing the economy over the long run and dramatically increasing interest costs.CBO estimates that if the baseline scenario is allowed to take effect in 2013, it would reduce federal spending by $103 billion and increase tax revenues by $399 billion (and another $105 billion "mostly in revenue") through September 2013 (the end of FY2013). This would amount to a net total of $560 billion, roughly half the $1.2 trillion FY2011 deficit. The White House estimates that a family of four with an income of $50,000 to $85,000 would pay an additional $2,200 in federal taxes.
The CBO has identified the following metrics for its baseline and alternative scenarios for the period starting January 2013:
Estimated deficit for the first year
The CBO estimated that the total deficit of fiscal year 2012 (which ends on September 30, 2012) will be $1.171 trillion. The CBO also estimated that the total reductions to the fiscal year 2013 deficit by letting current laws take effect (which increase taxes and reduce spending) would be about $560 billion.Therefore, since the total US public debt was approximately $11.053 trillion as of July 2012, the public debt would climb by the end of FY2013 to either $11.664 trillion (if Congress does nothing, allowing current law to take effect) or $12.224 trillion (if the fiscal cliff is avoided, extending current tax and spending policies into the future), all other considerations remaining the same. This difference amounts to 5.07% of the federal debt in nine months.
Under current laws scheduled to take effect by the end of 2012, the total 2013 deficit will be $612 billion, as opposed to $1,171 billion for the previous year. The chart at the right contains a breakdown of the currently authorized reductions to the FY2013 deficit. The total of this chart is $606 billion but this is without considering economic feedback. Reduced taxes and increased spending, due to the 1.3% contraction in the first half of 2013, as well as other constraints, are expected to decrease the savings by $47 billion, giving a net total of $560 billion in deficit reduction during FY2013.
CBO analysis of policy options
The CBO reported in November 2012 the economic and employment effects of various policy options related to the cliff. Each option has a different GDP and employment impact per dollar of deficit impact. In other words, some choices are more economically efficient. CBO explained why spending cuts have a more significant adverse impact on the economy than tax increases per dollar of deficit reduction: ?The larger 'bang for the buck' next year of the spending policies under the alternative fiscal scenario occurs because, CBO expects, a significant part of the decrease in taxes (relative to those under current law) would be saved rather than spent."Effects of sequestration
The spending reduction elements of the fiscal cliff are primarily contained within the Budget Control Act of 2011, which directed that both defense and non-defense discretionary spending be reduced by "sequestration" if Congress was unable to agree on other spending cuts of similar size. Congress was unable to reach agreement and therefore the sequestrations are expected start taking effect on January 2, 2013 if Congress, and President Obama, do not agree to a budget deficit reduction plan. The scope of the law excludes major mandatory programs such as Social Security and Medicare.The effect on both defense and non-defense discretionary spending will be significant if the cliff is not avoided. Cuts totaling $110 billion per year will be applied from 2013 to 2022, split evenly ($55 billion each) to defense and non-defense discretionary spending. For scale, discretionary funding for 2011 totaled $1,277 billion: budget authority of $712 billion for defense and funding totaling $566 billion for non-defense activities.
During 2013, defense and non-defense discretionary spending would be maintained around 2012 levels due to the sequester. However, the spending begins to rise thereafter, but not at the pace projected prior to the sequester. In other words, the trajectory of spending increases is reduced, but spending is not frozen at 2012 levels. Defense and non-defense discretionary spending increases from 2013?2021 would be about 1.5% annually, significantly below the prior decade.
For example, according to the CBO Historical Tables, defense spending (including overseas contingency operations for the wars in Iraq and Afghanistan) grew from $295 billion in 2000 to $700 billion in 2011, an annual growth rate of 8.2%. Non-defense discretionary spending grew at a 6.6% annual rate during that time, from $320 billion to $646 billion.
The austerity represented by the sequester is not unprecedented; from 1990?1999, defense spending actually declined by about 1% annually, from $300 billion to $276 billion, although non-defense discretionary spending grew by 4.5% annually, rising from $200 to $297 billion.
The CBO estimated the possible impact on defense spending in October 2011 testimony: "Compliance with the caps on discretionary funding could occur through many different combinations of defense and non-defense funding. For example, defense and nondefense appropriations might be cut proportionally relative to the funding that would be necessary to keep pace with inflation. In that case, funding for defense programs apart from overseas contingency operations would drop from $552 billion in 2011 to $538 billion in 2012 before rising again and reaching $637 billion in 2021 (see Table 3).
Between 2012 and 2021, such funding would be $445 billion less than the amount that would occur if the amount of funding for 2011 grew at the rate of inflation. When measured as a share of GDP, funding for defense would decline by about 1 percentage point from 2011 to 2021, or by more than one-fourth (see Table 5). Funding for defense in 2021 (excluding overseas contingency operations) would represent 2.7 percent of GDP; by comparison, annual funding for defense (excluding overseas contingency operations) has averaged 3.4 percent of GDP during the past decade."
The CBO estimated the possible impact on non-defense discretionary spending in October 2011 testimony: "If defense and nondefense appropriations were cut proportionally relative to the funding that would be necessary to keep pace with inflation, nondefense budget authority would decrease from $511 billion in 2011 to $505 billion in 2012 before rising again and reaching $597 billion in 2021 (see Table 4). Between 2012 and 2021, budget authority for nondefense purposes would be $418 billion less than the amount that would be provided if funding grew at the rate of inflation after 2011. Under an assumption that the obligation limitations for certain transportation programs grow over time at the rate of inflation, nondefense funding in 2021 would represent 2.8 percent of GDP; by comparison, such funding has averaged 4.1 percent of GDP during the past decade (see Figure 6)."
Effects of tax increases
Various sources estimated the 2013 impact on taxpayers (individual and married filing jointly) from the tax increases that would occur if the Bush income tax cuts and Obama payroll tax cuts are allowed to expire. The table below shows the dollar and percentage increase in taxes due and assumes two federal allowances are taken. The interactive tool at the source cited can be adjusted based on the reader's circumstances.{|class="wikitable" style="text-align:center" ! Income Level / Filing status ! Single ! MarriedFiling Jointly |- | $50,000 | $1,576 / 18% | $1,870 / 26% |- | $100,000 | $4,076 / 17% | $3,272 / 17% |- | $150,000 | $5,850 / 15% | $5,046 / 15% |- | $200,000 | $7,350 / 13% | $6,546 / 14% |}
Commentary
Many experts have argued that the U.S. should avoid the fiscal cliff while taking steps to bring the long-term deficit and debt trajectory under control. For example, economist Paul Krugman recommended that the U.S. focus on employment in the short-run, rather than the deficit. Federal Reserve Chair Ben Bernanke emphasized the importance of balancing long-term deficit reduction with actions that would not slow the economy in the short-run. Charles Konigsburg, who directed the bi-partisan Domenici-Rivlin deficit reduction panel, advocated avoiding the fiscal cliff while taking steps to reduce the budget deficit over time. He recommended the adoption of ideas from deficit panels such as Domenici-Rivlin and Bowles-Simpson that accomplish these two goals. Conservative budget experts have opposed calls to raise taxes or to allow defense sequestration, and have called on congressional leaders to return to normal budgetary process. Patrick Knudsen, a Heritage Foundation fellow, argued that lawmakers should seek long-term stability by rejecting short-term fixes and "grand bargains."Financial news networks CNBC and CNBC.com are launching a network-wide initiative aimed at calling attention to the fiscal situation. The network?s campaign is called ?RISE ABOVE?, a call to action appealing to everyone to rise above partisan political views in an effort to come to agreement on a plan that tackles both the long and short term challenges to the American economy. CNBC plans to engage business leaders, politicians and viewers through a series of programming efforts designed to increase the understanding of the core issues and to raise the level of dialogue beyond the rhetoric and talking points that have saturated media coverage of the 'fiscal cliff.'
Former Secretary of Defense Robert Gates stated in October 2012: ?Sequestration in 2013 will lead to a reduction of $1.2 trillion in the federal government?s discretionary spending, with half of that coming from the defense budget. Such deep across-the-board cuts in defense spending will not only wreak havoc on the economy of military-connected communities such as Huntsville but will also "do great damage" to the U.S. military, homeland security, aviation programs and other government entities that keep America strong at home and overseas.?
Proposals to mitigate the fiscal cliff
Congress
Congressional Republicans have proposed that the Bush tax cuts be extended in their entirety. In August 2012, the Congressional Budget Office (CBO) estimated that extending these tax cuts for the 2013?2022 time period would add $3.18 trillion to the national debt relative to the current law baseline, comprising $2.74 trillion in foregone tax revenue plus another $0.44 trillion for interest and debt service costs.
On July 25, 2012, the U.S. Senate voted 51?48 to pass a bill supporting the President's tax proposal which extended cuts for most taxpayers, while rejecting the Republican proposal of extending the tax cuts for all 45?54. The U.S. House of Representatives rejected, 170?257, the President's tax proposal on August 1, 2012.
As of November 1, 2012, a group of senators, now called the Gang of Eight, composed of Democratic Whip Richard J. Durbin D-Il., Finance Committee member Tom Coburn, R-Okla., Budget Committee Chair Kent Conrad, D-N.D., Sen. Michael F. Bennet, D-Colo., Sen. Mark R. Warner, D-Va., Finance member Mike Crapo, R-Idaho., Sen. Saxby Chambliss, R-Ga., and Sen. Mike Johanns, R-Neb., have been working since 2011 but "[have] so far failed to reach an agreement after more than a year of talks." Because of the number of spending cuts and tax changes, at least half a dozen committees, such as the House Ways and Means and Senate Finance committees, might want to weigh in on the bill.
On November 28, 2012, certain Republicans, such as Orrin G. Hatch (R-Utah), support "modifying tax expenditures as a way to raise revenue."
IRS
In a three-page letter, Steven Miller, acting IRS Commissioner, outlined the effects of the fiscal cliff and said that the IRS is working under the assumption that Congress would "patch" the Alternative Minimum Tax (AMT). The patch prevents the AMT from impacting many more taxpayers. This is similar to what Congress has done in previous years. CBO estimated in August 2012 that if the patch were not implemented, federal revenues would rise by a total of $864 billion over the 2013-2022 period.President Obama's position
During November 2012, President Obama expressed a preference for replacing the more blunt cuts of the sequester with more targeted cuts, while raising income tax rates on the top 2% of earners. Senior White House officials recommended a veto of any bill that: 1) averts defense cuts while leaving intact non-defense cuts; or 2) excludes an increase in tax rates for top earners. Obama wants to continue to extend the Bush tax cuts for American couples earning less than $250,000 and individuals earning less than $200,000.Treasury Secretary Timothy Geithner is Obama's lead negotiator about the fiscal cliff and the increase in the 2013 debt limit.
As of November 30, 2012, Obama is supporting an undeclared amount of spending cuts, $1.6 trillion in higher taxes over ten years, and cuts of $400 billion from Medicare and other benefit programs over a decade. Also, Obama wants to include "an extension of the 2 percentage point payroll tax cut" and spend "at least $50 billion" in 2013 "to boost the economy."
Timeline
March 23, 2010: President Obama signed into law the Patient Protection and Affordable Care Act. One of this law's provisions is to impose new taxes on families making $250,000 per year or more starting in 2013. December 17, 2010: Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, patching the AMT through 2011 and extending the Bush tax cuts to the end of 2012. August 2, 2011: The President signed the Budget Control Act of 2011. This act provided that, if the Joint Select Committee did not produce bipartisan legislation, across-the-board spending cuts would take effect on January 2, 2013. February 22, 2012: Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012, which extended the following provisions until December 31, 2012: the 2% Social Security payroll tax cut, federal unemployment benefits and the freeze on Medicare physician payments. February 29, 2012: Ben Bernanke popularized the term "fiscal cliff" in his testimony before the House Financial Services Committee. July 3, 2012: IMF head Lagarde warned that the threat of "going over the fiscal cliff" could weaken the US economy later in 2012. The IMF also reduced its projection for US growth in 2013 from 2.4 to 2.25 percent of GDP. July 17, 2012: Bernanke pushed Congress to avoid the fiscal cliff, warning that a failure to do so will further dampen the sluggish economic recovery. July 31, 2012: Reid and Boehner agreed on a continuing resolution that would pay for the day-to-day running of the government until the end of March 2013. This does not affect the fiscal cliff or the debt-ceiling. August 7, 2012: Obama signed the Sequestration Transparency Act of 2012, which directed his administration to detail in 30 days how they plan to implement the automatic cuts mandated by the Budget Control Act. September 14, 2012: Obama released his 400-page document detailing cuts. http://cdn.govexec.com/media/gbc/docs/pdfs_edit/091412cc1.pdf October 22, 2012: At the third of three presidential debates, Obama says sequestration will not happen. November 16, 2012: US leaders announced that they met to discuss the fiscal cliff and perhaps develop an approach that would be ready to present the week of November 26, 2012. November 29, 2012: Treasury Secretary Timothy Geithner presented a plan to congressional leaders to correct the fiscal cliff.See also
Notes
References
Further reading
External links
Category:Government finances in the United States Category:Presidency of Barack Obama Category:112th United States Congress
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