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 If politicians did dive off the cliff, it would likely be temporary and likely rescinded later in 2013 in an effort to stave off a recession.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 end. Our 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?