What is the Fiscal Cliff (and why should you care)

My understanding is David Letterman told a Fiscal Cliff joke last night, but how many people fully understand what the term means? I bet Jay Leno does one of those things where he asks people on the street what the Fiscal Cliff is and gets nothing but blank stares or answers that refer to a pending action film coming out in December.

The Fiscal Cliff is a term used to describe some measures that will automatically take effect on January 1, 2013. It is a combination of higher taxes and lower spending that is projected have a long term positive impact on the federal government’s fiscal health. The concern is the short term impact on the economy which according the Congressional Budget Office could be significant. 

For example under current spending and tax scenarios 2013 GDP Growth is projected to be 1.7%, under the Fiscal Cliff scenario GDP Growth is expected to come in around -0.5% , which would be defined as a recession. Those types of numbers often fly over people’s heads, but this projection does not. Under current policies the projection for unemployment at the end of 2013 is 8% which the projection for unemployment is 9.1% under the Fiscal Cliff scenario. I think that hits closer to home with more people.

On the other side of the equation (and something that does not get a lot of attention) is the long term benefit of higher taxes and lower spending. Current projections peg the national debt at 90% of GDP in 2022 based on our current path, while projections based on Fiscal Cliff measures put the national debt at 58% of GDP – a more manageable figure. 

The conclusion from the Congressional Budget Office is this – an agreement that avoids the Fiscal Cliff will yield near term economic benefits, but result in further accumulation of the national debt. To me is sounds like we can pay now or pay later and Washington will end up making that decision for us in the next few weeks.

Russell Rhoads

CBOE