Explaining the Fiscal Cliff

Now that the election is over, news outlets seem to cover nothing but the royal baby and the fiscal cliff. While news about Will & Kate’s future offspring is easy to grasp, information on the fiscal cliff is more complex and deserves a more in-depth explanation than it has gotten.



The “fiscal cliff” is a shorthand term referring to the effect of a number of laws that (if unchanged) could result in tax increases, spending cuts, and a corresponding reduction in the budget deficit beginning in 2013. If these changes go into effect, the deficit — the difference between what the government takes in and what it spends — is expected to be sharply reduced, while taxes will sharply increase, hence the analogy to a cliff.

The big revenue increases or spending cuts come from these laws:

  • Expiration of the Bush tax cuts extended by President Obama in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010;
  • Across-the-board spending cuts (“sequestration”) to most discretionary programs as directed by the Budget Control Act of 2011;
  • Reversion of the Alternative Minimum Tax thresholds to their 2000 tax year levels;
  • 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);
  • Expiration of the 2% Social Security payroll tax cut, most recently extended by MCTRJCA;
  • Expiration of federal unemployment benefits, as extended by MCTRJCA and
  • New taxes imposed by the Patient Protection and Affordable Care Act (Obamacare) and the Health Care and Education Reconciliation Act of 2010.

If thinking about the policy implications of changing one or all of these laws was not enough, Congress must address the federal debt limit, which is set by law at $16.4 trillion. The national debt is approaching $16.3 trillion, and, as discussed below, the prolonged negotiations over the debt ceiling increase in 2011 are one of the reasons the cliff exists.


A video crash course on the budget and the fiscal cliff from the Wall Street Journal.


For the most part, the fiscal cliff is a planned event.

During the summer of 2011, deficit spending previously appropriated by Congress was bringing the federal government’s total debt close to the statutory debt ceiling. Republicans in Congress refused to approve an increase in the ceiling unless corresponding spending cuts were enacted that would lead the country toward a more balanced budget. The Budget Control Act increased the debt ceiling and provided for automatic spending cuts to begin on January 2, 2013.

The 2013 start date seemed like a good idea at the time. Congress acted on the debt ceiling and avoided a government shutdown and the 2013 date seemed close enough to be a serious threat but far enough away that action could be taken by Congress to make more reasoned, policy-driven spending cuts.

The fact that January 2013 also marks the expiration of the Bush tax cuts is no coincidence. Congress set itself up for hard choices by timing these events so they would fall after the election and during a lame duck period.


Cutting government spending and reducing the deficit are generally viewed as positive events, but with regard to the fiscal cliff such is not the case. The Congressional Budget Office (CBO), which tells Congress the economic and fiscal impacts of its decisions, estimates that allowing the country to go over the fiscal cliff would send the economy into another recession.

The recent or scheduled expirations of tax provisions, such as those that lower income and payroll tax rates and limit the reach of the alternative minimum tax (AMT), will boost tax revenues considerably in 2013 compared with the sums that will be collected in 2012. The automatic enforcement procedures established in the Budget Control Act of 2011 (Public Law 112-25) will lower spending in 2013 compared with outlays in 2012. And other provisions of law will generate additional deficit reduction in 2013.

Taken together, CBO estimates, those policies will reduce the federal budget deficit by $607 billion, or 4.0 percent of gross domestic product (GDP), between fiscal years 2012 and 2013. The resulting weakening of the economy will lower taxable incomes and raise unemployment, generating a reduction in tax revenues and an increase in spending on such items as unemployment insurance. With that economic feedback incorporated, the deficit will drop by $560 billion between fiscal years 2012 and 2013, CBO projects.

Much attention has also been devoted to the impact the sequestration will have on national defense if an agreement modifying the summer 2011 deal is not reached. A disproportionate amount of the automatic spending cuts come from the defense budget. This is troubling as the nation’s troops are engaged abroad and defense contracting is a relatively large segment of the national economy.


Members of Congress and Pres. Obama claim they are currently working on a deal that will avoid a recession. However, avoiding a recession seems to be the only point of agreement between all of the involved parties. Democrats control both the White House and the Senate but Republicans hold the House of Representatives, which is where all revenue bills must originate.

Demands and offers from both sides change virtually daily, but there are a handful of central points of disagreement.

  • Democrats would like to see the Bush tax cuts expire for at least the wealthiest individuals, while Republicans would keep the rates low but reform the tax code to remove loopholes and deductions. Two deductions that are already generating a lot of discussion (against cutting them) are the mortgage deduction and the charitable deduction.
  • 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.
  • Entitlements, in particular Social Security, Medicare and Medicaid—pensions, and health care for the elderly and poor, respectively—are a hot topic. Many Democrats do not want to touch the programs, while Republicans argue the programs must be modified if they are to be sustained in the long run.
  • To further complicate matters, many Republicans signed a pledge indicating they would not raise taxes. Allowing the Bush tax cuts to expire is essentially a tax increase, so for many Republicans this is not an item they are willing to trade in exchange for cuts elsewhere.

Additional Information
CBO – The non-partisan legislative branch office that provides data and analysis to Congress.

Times Topic: Federal Budget (The ‘Fiscal Cliff’) – News coverage and reference materials compiled by The New York Times.

Fiscal Cliff: The Wall Street Journal – Information on the fiscal cliff from the WSJ.

Office of Management and Budget – The White House office that prepares the President’s annual budget proposal.

National Commission on Fiscal Responsibility and Reform (Simpson-Bowles) – The bi-partisan commission that President Obama appointed to recommend ways to balance the budget.

Use this online simulator from The Committee for a Responsible Federal Budget to stabilize the US debt at 60% of GDP by 2021.