December 31, 2012 is a date that looms large on the calendar of U.S. politicians, bankers and investors. It is a day that many associate with a cataclysmic event that will change the American way of life; it is the day that the U.S. will stumble over the "fiscal cliff'. Fear mongering and political maneuvering are central to the "fiscal cliff' story detailed in headlines, which report on frantic last minute negotiations between Democrats and Republicans to advert the near disaster.
The "fiscal cliff', however, is an invented term applied by politicians to the date various temporary legislative changes to the country's tax code and spending policy take effect. Politicians began instituting temporary tax cuts with the intention of later transforming them into permanent law in the 1990s. According to a Center on Budget and Policy Priorities report, this practice exploded during the George W. Bush administration and was accompanied by budget gimmickry to hide their affect on the federal deficit.
The Bush era tax cuts, known respectively as the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003, are at the center of the storm that is raging around the "fiscal cliff'. The legislation, which was set to expire in 2010 but was extended to 2012, significantly reduced rates on income, estate and dividends and capital gains taxes and exemptions.
After the sunset of the Bush era tax cuts, estate and gift tax exemptions will end raising the tax rates on transferred estates over $1 million to 55%. Long-term capital gains taxes will rise from its current rate of 15% to 20%. The tax bracket for the country's wealthiest citizens will rise from the current 35% to 39.6%. In other words, the tax code will largely return to the rates that were in place prior to the George W. Bush administration.
This return to the pre-Bush era tax code, coupled with the implementation of spending cuts to reduce the federal deficit and tax penalties associated with health care reform, have many economists screaming recession. Fear of a recession has politicians scrambling to reach a deal that would prevent the parameters of already established legislation from taking effect. The Republican demand in "fiscal cliff' negotiations in Congress: the permanent implementation of the Bush era tax cuts.
The Congressional Budget Office reported that the Bush era tax cuts were responsible for 14% of the swing from federal budget surplus to federal budget deficit over 2002-2011. The Council of Foreign Relations projects that a permanent extension of the tax cuts will increase federal debt by $3 trillion over the next 10 years. However, due to the fear inspired by the economic catastrophe that is associated with the "fiscal cliff', the temporary tax cuts instituted to fulfill the campaign promises of George W. Bush may become permanent under Barack Obama.
So what are the consequences of jumping off the "fiscal cliff'? According to many experts, there are none, because the "fiscal cliff' does not exist. Ken Fisher, named as one of the thirty most influential people in the investment industry, pointed out in an interview with Forbes that changes to the tax code and federal spending do not take affect in one fell swoop. He refers to the "fiscal cliff' as, "more of a fiscal rolling plain." (Ken Fisher Talks the Fiscal Cliff, Forbes, 12/18/2012)
The Congressional Budget Office (CBO) Report "Economic Effects of Reducing the Fiscal Restraint that is Scheduled to Occur in 2013" has given fodder to "fiscal cliff' apocalypse theories. The CBO projects tax hikes and federal spending cuts will produce a mild recession. However, the report also states that if the current tax and spending policy is extended debt will rise faster than the GDP and by 2022 the federal debt owned by the public will reach 93% of the U.S.'s Gross Domestic Product.