The beginning of 2013 could be a disaster for our economy. We’re facing a number of different situations that individually could throw us back into recession. All around the same time we will face three things:

  • Another debt ceiling vote
  • Automatic tax increases (either through expiring credits or otherwise)
  • Automatic spending cuts

The last debt ceiling vote was a disaster.  It proved that the Congress we have in place is incapable of compromise.  And many of the spending cuts and tax increases are a result of the failed Super Committee.  But there other factors at play such as new items from Obamacare coming into effect.

Cutting of government spending, in the form of budget cuts and reduced unemployment insurance, will alone take a chunk out of the economy. But tax increases will take more out of the pockets of those with paychecks. And the debt ceiling vote could cause so much more instability no one wants to invest in US growth and another downgrade of US debt. With a downgrade comes the fear of rising interest rates on government debt. This perfect storm is being referred to as a “fiscal cliff” that could throw the US back into a recession.

Take a look at this article from the LA Times (emphasis mine):

Federal Reserve Chairman Ben S. Bernanke, in testimony Thursday before Congress, repeatedly warned about the so-called fiscal cliff — a reference to the expiration of tax cuts Dec. 31 and the imposition of automatic spending reductions Jan. 1.

By some accounts, the U.S. economy could see an unprecedented fiscal hit of as much as $720 billion if the slated changes take effect.

The article continues:

As the cliff approaches, we expect first firms and then households to start postponing decisions, weakening the economy in advance of the cliff,” economists at Bank of America said in a report this week. “When you are approaching a cliff, in a deep fog of uncertainty, you slow down.”

Image: Lisa Andres

Forbes and StarTribune outline further details of what could occur should we fall off this cliff.  The latter outlines many of the changes to tax and spending line by line and goes so far as to explain the effect as “waking up on Jan. 1, 2013, to $10-per-gallon gasoline prices”.

But many may be ignoring how painful these cuts may actually be. Unlike what the StarTribune article implied, the effects of these fiscal changes wouldn’t be felt overnight. The spending cuts wouldn’t occur at once. They would take 12 months or more to actually roll out. The increased taxes will be felt somewhat immediately, but anyone with any level of discretionary income will be able to absorb the increases. Plus, the tax changes could be fixed retroactively over the course of the year should the political process deem it necessary.

What no one denies is that the cuts will take a chunk out of the economy. We must decide if we are OK with the changes in the name of more fiscal responsibility and if we are prepared to absorb the blow. Where there is room for debate is whether this is actually a cliff or more like a gentle downward slope. Regardless, I agree with a small minority that this isn’t the fiscal crisis that the media will being playing up soon. It’s something that must be addressed, but not necessarily before the clock strikes 12 on January 1.

Read: Fiscal Cliff May Not Be That Scary. No Deal In Lame Duck Is Needed

categories: economics, government