Sample – ECON200-Topic #6 Fiscal Cliff and Spending

The “fiscal cliff” refers to a series of tax and spending cuts that are due to expire at the end of 2012. Politicians from both parties decided to wait for most of the election year to deal with the cliff for mostly political reasons. In an election year, Republicans didn’t want to be seen raising taxes, and Democrats didn’t want to be seen as cutting entitlements.  While many agree that something must be done, there is substantial disagreement about how to go about solving this problem. The choice essentially comes down to a “grand bargain” and “diving off the cliff.”  If politicians did dive off the cliff, it would likely be temporary and likely rescinded later in 2013 in an effort to stave off a recession. However, there is no guarantee to even a temporary solution.

In any event, if nothing is done before the end of the year, tax rates will rise on everyone, spending will be cut in both the military and domestic programs, unemployment benefits will end for some, and other programs will endOur class discussed the potential outcomes of the fiscal cliff before the election, and I want you to revisit this issue with a fresh perspective. There are global consequences if nothing is done. Consumption would likely fall if the cliff is crossed, but might even suffer if there is a deal between the House and the President. Military spending might fall to the point that our national safety is compromised. Note that this would substantially impact the state of Virginia which is highly dependent on military and military contractor spending. Military cuts would threaten other policy goals even at the state level such as education and health care.

Questions you might answer

  • Approach this question a bit differently, by framing some issue about the fiscal cliff that is not stressed here. I don’t especially want to hear summaries of potential compromises, but rather the broader impact that a bargain or diving would have on consumption, investment, government spending, or net exports.
  • Can states adequately prepare for the fiscal cliff? What might happen in the state of Virginia, or your home state, if we permanently or temporarily dive off the cliff?
  • What would happen to consumers if we dive off the cliff or if there is a grand bargain? Just because we anticipate an economic contraction does not mean it is unnecessary.
  • What do you expect the Federal Reserve to do in response to a grand bargain or full on dive?

17 thoughts on “Sample – ECON200-Topic #6 Fiscal Cliff and Spending”

  1. As the United States quickly approaches “diving off the fiscal cliff” in January 2013, state legislators have begun preparing for the worst. According to Paul Vigna of the Wall Street Journal, “state budget chiefs have begun setting aside money and looking for programs they can quickly scale back if leaders in Washington fail to reach a deal to avoid sending the economy over the so-called fiscal cliff.” Since there is continued uncertainty about the outcome of this decision, many states are preparing two budgets for the upcoming year- one for going over the fiscal cliff and one without. Although the states have attempted a plan for action to prepare, many states are heavily reliant on federal funding in their budgets and cannot afford the losses from proposed spending cuts. For example, the state of Rhode Island relies on the federal government for one-third of its funding for the budget. Cutting even more spending in addition to what has already been cut over the past few years during the recession will be detrimental to the state’s economies. In addition to decreased federal funding, many defense contracting and civilian jobs will be cut due to the military spending cuts proposed in the fiscal cliff. To prepare for the upcoming “dive,” states have begun searching for areas of military spending to begin quickly scaling back, such as postponing ship building at naval bases or stalling civilian projects. With such uncertainty, it seems impossible that the states can adequately prepare for the fiscal cliff, but with time quickly ticking, state legislators have been scurrying to gather emergency funds and searching for areas to cut in preparation for the dive in 2013. This limited preparation will not be sufficient to save the states economies and will increase unemployment, raise taxes, and inhibit growth, pushing the economy back into recession.

  2. Since the Presidential election has ended, much of the debate consuming the twenty-four hour news cycle has shifted towards the daunting “fiscal cliff”, which includes the expiration of the Bush era tax cuts (which had previously been extended by President Obama) and automatic spending cuts that would affect the military and many domestic programs. Much of the talk recently has been about a proposed “Grand Bargain” between President Obama and Speaker Boehner that would target about four trillion dollars in deficit reductions over the next ten years, with $2.50 in spending cuts for every $1 in new revenue raised by increasing taxes on individuals making over $250,000 and by also closing some tax loopholes and deductions.
    For the last few weeks the media has been pushing the “fiscal cliff” as some horrible, irreversible tragedy that would befall our country and send us spiraling toward another Great Depression. However, this is certainly not the case. The problem with our current infatuation with balancing the books all of a sudden is that there is still a very high level of unemployment in our country with millions of Americans still struggling to make ends meet. To focus on “tightening our belts” now in regards to reigning in our deficit and debt, would be a big mistake. Tax increases and reduction in spending on such things as unemployment benefits will make a financial recovery a much tougher prospect than it already is. While reducing our deficit and debt is very important for the future, now is not the time to take serious action. The best way to ultimately reduce our deficit and debt is to build up our financial foundation by going all in on education by reforming and improving the current system so we can actually produce workers with the necessary skills to fill the jobs that our currently available in our country. Through the ongoing discussion of the fiscal cliff, we have lost sight of what is truly important, helping those that our out of work and those that have been hit hardest by the recession. We need to focus on renew our focus on this before we begin our “belt tightening.”

  3. When discussing the rising tax rates that are associated with the “fiscal cliff”, one key aspect is the alternative minimum tax, or AMT. The AMT requires people to calculate both their regular tax rate and the AMT. Whichever one is higher determines how much they owe in taxes. This tax was initially created in 1969 to prevent the very wealthy from avoiding tax payments through various deductions. However, the established AMT salary is not automatically indexed for inflation and over time, more middle class earners have become eligible for this tax.
    Traditionally, each year Congress issues a “patch” on the AMT to protect these middle-class earners from paying it. Approximately 28 billion more Americans will have to pay the AMT in 2012 if Congress does not elect to continue these patches. The average tax bill of these Americans will increase by $3,700 this year.
    The AMT is a large source of government revenue and it is unlikely that it will be abolished. Even if the AMT became automatically indexed to inflation, there would still be a significant decrease in government revenue.
    One proposal to reforming the AMT is to make the AMT progressive, meaning that the AMT would increase for particularly high earners. This solution might help increase government revenue and allow Obama to follow through on his campaign promise to raise taxes on the very wealthy, but it does little to help many of those middle-class earners who are looking at paying the AMT for the first time this year.

  4. With the fiscal cliff looming over the American consumer, you would expect consumption to be on a decline. However that is not the case. According CNBC’s Steve Liesman, consumer confidence is currently at a five year high at 73.7 percent. Someone needs to inform the American consumer. If no deal is made, the American consumer will see some detrimental things happening to their taxes and income.
    Andrew Levin, co-chair of and Identity Theft 911, suggests the American consumer save up money for 6 months worth of costs because they don’t know what could happen to them, they might get laid off especially if they have a defense job. He also suggests that the American consumer should put money away in their 401K to make it un-taxable and it will be more money for them later on.
    According to the Tax Foundation, if nothing is done, meaning no deal is made and all the Bush-era tax cuts and Obama tax-cuts are taken away, the average middle-class American family will see an increase of $7,000 dollars to their tax bill at the end of the year. Meg Handley of states that with an end to the Bush-era tax cuts, the lowest tax bracket can see an increase from 10 percent to 15 percent and the highest income bracket would be at 39.6 percent. She also discusses the effect on payroll taxes and says that if more taxes are withheld each paycheck that workers will have less take-home pay which will have a major impact on spending.
    A new report from Obama’s Council of Economic Advisers states that allowing the middle-class tax rates to rise could cut the growth of real consumer spending by 1.7 percent and could ultimately slow the growth of GDP by 1.4 percent. The CEA also estimates that consumers could spend nearly $200 billion less than they otherwise would of paid in 2013. In conclusion if no deal is made and we dive off the fiscal cliff, the average American consumer will be greatly affected. A deal must be made in order to save American consumption.

  5. The fiscal cliff is approaching at a rapid rate with no clear cut solutions in sight. Unfortunately, some of the legislating body is threating to let country fall off of this proverbial cliff in order to decrease the deficit. However, this could have detrimental effects on Virginia’s economy. Virginia currently has a large percentage of workers that rely on the government indirectly. Specifically, northern Virginia houses some of the largest government contracting companies such as Lockheed Martin, Northrop Grumman, SAIC, Raytheon and Booz Allen. These companies signed multibillion dollar contracts; Lockheed Martin, for instance signed 17.4 billion dollars in contracts in 2012, which is then redistributed to many northern Virginian families through paychecks. By cutting defense spending, these companies will have to scale back on their labor force, which will, inevitably, increase the unemployment rate most notably frictional unemployment. This, in turn, would increase the number of people that need government assistance and increase the budget deficit even more. Although this could create economic problems, it could, in fact, be beneficial in the long run. The frictionally unemployed, most of them successful engineers, will most likely find jobs and it could create a unique kind of structural unemployment. They have unique skills that are currently used for defense; however, with some new training, links between the sciences (physics, biology, and chemistry) could be exploited to make further advances in biotechnology and medicine.

  6. If the United States was to simply “dive off the fiscal cliff,” we would be looking at a $600 billion loss to American consumer income. But, even if a grand bargain is made, it is predicted that consumers would still be losing $218 billion. The Goldman Sachs investment banking firm calculates that this loss in consumer income will correlate to a $110 billion loss in consumer spending, based on marginal propensity to spend. After looking at past events Goldman analyst Matthew Fassler believes “categories that could be most impacted [by the decrease in consumer spending) include autos, consumer electronics, home furnishings, home improvement, lodging and gaming, specialty apparel, and sporting goods. Categories that could be least impacted include drug stores, food, and tobacco.” The impacted markets will doubtlessly suffer, but not as much as they might have if nothing was done. Despite the coming “fiscal cliff”, consumers seem relatively calm. According to the Conference Board’s Consumer Confidence, shopper confidence rose this November to its highest level since February 2008. The University of Michigan poll of shopper psyche also found consumer confidence at a five-year high in November as well. Perhaps the growing confidence of consumers is a signal that the US economy has recovered enough to handle the approaching tax cuts, or perhaps it is just a show of how ignorant Americans are when it comes to the economy?

  7. With the fiscal cliff soon arriving by the start of 2013 many politicians have begun stating outcomes and proposing plans for the best possible outcome. Firstly, if we were to ‘dive’ the cliff there would be a general tax rate increase, as well as a large budget cut, taking away about $1.2 trillion in discretionary and military combined. The other end of this is to simply put off the discussion of the matter, or make a short term bargain of interests, and make do with the current policies. This, however, leads to an increase of the debt, neglecting the overall goal. The former would lead to many poor outcomes for the GDP; with a higher tax rate for middle America there would be about $200 billion used less in consumption, a dramatic lowering of business investments to stay in line with the decreasing demands, and less government spending, primarily in military by about $500 billion. With less money being put into purely military other countries might compromise America’s dominance in foreign markets, also lowering the GDP by decreasing net exports. A closer, in depth result of diving the cliff appears in the American consumer. If we were to dive the cliff a typical American family would make $250,000 less a year than in previous years, resulting a large decrease of spending on generally anything. This would ultimately put the burden on both retail stores and the unemployment rate through a decrease of demand in the market, lessening the strength of our economy. One plan to avoid such results is to only let the wealthy tax cuts expire, leaving the wealthiest 2 percent paying a higher 39% compared to an older 35%. The fiscal cliff must be taken care of by assessing both the future security of the US economy in regards to both the debt and deficit, as well as current position of the many of working, middle Americans.

  8. It is interesting that some would say Americans have no clue what is occurring in the government and that consuming has not had much of an impact, because the chart of stocks begs to differ in that section. This year, the stocks plummeted, with the stock indexes losing more than 2.5 percent of their value. Why did this occur? The sharp drop reflects investor calculations that next year will suffer from an imposition of $500 billion in tax creases and spending cuts. Conflicted thinking between what steps to take next is centered between President Obama and House Speaker Boehner. However, if they cannot discover a solution, then the Federal Reserve is supposed to step in. Federal Reserve Chairman Bernanke says that if a decision cannot be made, this will throw the government off the broad fiscal cliff, which will send us into a recession. He says “I don’t think the Feds have the tools to offset that,” stating that there is really nothing they can do in this matter. He worries that due to people simply waiting for a result, which causes a rise in lost economic potential, leading to a costly rise in unemployment. While he could offer no advice, he says the Federal Reserve expects to keep the interest rates near zero until 2015. If a decision can be made, not even the Federal Reserve will be able to help us.

  9. The fiscal cliff has been made out to be incredibly ominous to regular citizens by the news because no one likes the sound of higher taxes or government spending cuts. But, isn’t this exactly what we want in order to decrease the deficit? In reading these articles, I couldn’t help but to think back to the three poles that David Wessel presented in his book, Red Ink. A couple blogs back we discussed these poles and many agreed that the only plausible way to solve the deficit was the third pole, which was Pete Peterson’s idea that the government needs to cut spending and raise taxes. Raising taxes and cutting spending is the only way to create surpluses and isn’t this exactly what would happen if we did dive off the fiscal cliff?
    During Obama’s campaign, he often referred to his plan to go back to Clinton-era economics during debates. So I believe it’s safe to assume that we will be diving off the fiscal cliff at the end of this year. Although, this could be exactly what we need to fix the deficit, many companies and consumers are not as convinced. The negative connotation that has surrounded the fiscal cliff has caused many to become pessimistic about the future. In the short run this will most likely cause a decrease in consumption, investment, and net exports, causing a leftward shift in the short run aggregate supply curve. This could in the long run shift price levels up, which could be a negative effect.
    I don’t believe that going back to the exact same tax code put in place by Clinton is a good idea because our economy is very different then it was, so there does need to be some change. But, diving off the fiscal cliff may not be as bad as it sounds.
    Wessel, David. “Red Ink Inside the High-Stakes Politics of the Federal Budget.” New York: Crown Publishing, 2012.

  10. With the end of 2012 fast approaching, the fiscal cliff is coming closer with no current way of stopping it. While Congress figures out what they are doing, states start to plan for the worst in 2013. While Virginia is 28th on the list of which states’ households will be most affected by the cliff, we still have a far way to go before we are stable. The states that should be the most worried are New Jersey, Maryland, Connecticut, and Massachusetts, as they take the top four ranks with over 6 % increases in the amount of taxes expected to be taken from their income. In Virginia we are looking at a $4,500 tax increase in the next two years, while the top four are looking at a $6000-7000 increase. With less disposable income caused by higher taxes, less money will be spent per household, which will not help recovering businesses. On top of the monetary situation, many are saying that going over the cliff can hurt the health of everyone. Many people realize that going over the cliff will cut back on Medicare spending and food stamps, but other areas may be affected including the CDC, the National Institute for Health, fewer health inspectors within the FDIC, and the gradual decrease of social security. So even with the short-term tax increase, the monetary loss may not be the worst part of the long-term effects that diving over the cliff will cause, both in Virginia and nation-wide.

  11. A $503 billion budget contraction is something that no economy can withstand, let alone the still recovering United States economy. Yet, this is the exact course the United States is headed for if Congress decides to dive off the fiscal cliff. This will result in the expiration of the Bush tax cuts, which will raise all income tax rates, estate, and capital gains taxes, and simultaneously end the payroll tax cut, causing rates to rise from 4.2% to 6.2%. If this was not enough, the Affordable Care Act taxes are set to take effect in January 2013 meaning new taxes to Americans, on top of the tax cut expirations. The result of these tax policies will dramatically cut consumption in the United States, and according to Goldman Sachs, “…translate to a $110 billion bite in consumer spending.” The CBO projects unemployment rising back to 9% if the United States dives off of this fiscal cliff; which in turn means less people earning money and therefore spending less. The combination of tax policies and rising unemployment will negatively affect the largest portion of GDP, which according to NPR is consumption at 70%. Some might argue these are only estimates but what critics cannot argue are the automatic $1.2 trillion government spending cuts over the next 10 year, mandated by the Budget Control Act of 2011. NPR reports government spending as 19% of GDP and the mandated spending cuts of $109 billion/year from 2013 to 2021 will hurt the government spending category of GDP. The negative impact on consumption and government spending will damage the already weakened U.S. economy, possibly resulting in a double-dip recession. When a 1% change in GDP can mean the difference between an economic expansion and recession, imagine the consequences of the CBO estimated 4% reduction in GDP if Congress decides to dive off the cliff.

  12. The biggest losers of the fiscal cliff are the consumers because their well being is in the balance and their lives could be drastically changed. The level to which the consumer will lose will depend on the plan that Congress decides to adopt. There are 4 main possibilities that Congress could decide upon. Congress could decide to let all the tax cuts expire, mandate cuts in military and domestic spending, and reduce spending on other programs. This is going over the fiscal cliff. The Democrat and Republican plans are different only with who gets the tax cuts and which credits remain in place.
    By using the tax policy center’s tax calculator, you can determine how your taxes will change with each plan that is being discussed. An example is a middle income single person, who makes $18,600, will pay $802 more by going over the cliff. The result is going to change with either of the other plans discussed but will be lower. Consumers will be taxed more but where they will really be hurt is in the spending cuts and loss of unemployment benefits. Many people believe that the military spending cuts could endanger American troops and American security by requiring $.6 trillion to be trimmed over 10 years. The unintended consequences of this could be dramatic and could threaten the security of Americans throughout the world. The loss of government programs, especially unemployment benefits, will drastically diminish the American economy and could shuffle economic classes. The most affected group will likely be small business owners who will see drastic drops in sales and higher taxes. Although the country will benefit from a decrease in the deficit, the consumer cannot survive going over the fiscal cliff in a recession.

  13. The term “fiscal cliff” has been perpetuated as a doomsday of sorts for the United States. This simply isn’t true. According to nonpartisan research “even without a deal by year-end, the economy isn’t expected to crater”, maybe not as optimistic of a statement as one would hope but nonetheless is not the be all/end all for the US. Letting the Bush tax cuts expire would have some negative effects on the economy all of which we heard before, less disposable income, loss of military and civilian jobs and it is expected that this will harm consumption. An important factor in this is whether or not people are optimistic about a deal being made that will cushion the blow of tax increases. In the anticipation of taxes rising, people may severely reduce their spending and hurt the economy even more because of the less tax revenue coming in. If a bargain is reached before year’s end, consumers will not change their spending as dramatically and the economy can adjust. The component of GDP most involved would be government spending and taxes. In one hand, if the tax cuts expire (people will most likely panic first off) the economy will most likely see contraction due to less consumption and more government spending for entitlements but less spending in other areas such as military which is the long term plan for reducing the deficit. On the other hand keeping things the way they are will do exactly that and putting off this “fiscal cliff” will make it that much more severe when the time comes that we have to jump.

  14. One very important issue in this debate is the idea of certainty. State governments and businesses alike need to be certain of the upcoming economic conditions. Currently, investment is only at around 16.9% of GDP. This is up slightly from when it bottomed out in 2009 yet it is still below what it was in the recession of the early 90’s. One thing that will increase economic growth is an increase in investment. Historically and theoretically, the best way to do this is for the Federal Reserve to enact expansionary policy. Unfortunately, the Reserve is currently in the middle of the most expansive policy in history. Currently the Fed purchases $85 billion a month in long-term securities. And many, including Boston Federal Reserve Bank President Eric Rosengren, are in support of continuing this policy. But with the Federal Reserve already doing so much and economic growth continuing to barley inch along, something more must be done. Congress needs to lay out a plan that will decrease uncertainty and increase private investment. The issue here is not only that there will be tax hikes and spending cuts, but these cuts will be very big and enacted very drastically. The shock of these policies must be avoided by having a slowly implemented policy that focuses on incremental tax increases and reformation of the entitlement system, the driving force of the current debt.

  15. There is not enough time between now and the end of the year for politicians to negotiate the “grand bargain” Obama seeks. Assuming political progress is being made toward that objective, a one-year compromise could occur before December 31st, with negotiations for both tax and entitlement reform to follow in 2013. In this case, it is unlikely additional tax revenue will come from a tax rate hike, but instead from something like a deduction limit. According to the Tax Policy Centre, a $50,000 deduction limit would generate $750 billion over 10 years, so substantial revenue is available from this route. If insufficient political progress is being made, Obama’s hardball option is to let the “cliff” event occur, thereby automatically raising tax rates January 1st. At that point, tax rates can be negotiated back to current levels for all but the highest earners, thus allowing Republican politicians to maintain their pledges. If this scenario is wrapped up quickly in 2013, the adverse economic impact should be relatively modest, as legislation will be made retroactive to January 1st. Allowing the tax rates to rise on the middle class would cause a decline in consumption, cutting the growth of real consumer spending by 1.7%. This could in turn slow the growth of GDP by 1.4%. If the tax cuts occurred, consumers would be estimated to spend $200 billion less than they otherwise would have in 2013.

  16. @Susan Rogowski

    I like the perspective you took in this blog post but the lack of statistics hinders the arguement. More statistics would allow people to see facts about the side you’ve taken. I also like how you relate back to the Wessel book.

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