The term “fiscal cliff” is a powerful metaphor that has been used to describe various types of budget crises since as far back as 1975. Though its origins are in the cliffhangers of early cinema it’s currently being used to describe the massive spending cuts and tax increases that will take place at the end of the year if the president and Congress fail to act. Many investors and economists have argued that it is an exaggerated term, and that what will happen might be more accurately described as a “slope” or “hill.” Regardless of the terminology used, it is certain that there will be major consequences to the overall economy, businesses and consumers if policy makers are unable to come to some sort of long-term resolution for the deficit, taxes and government spending.
For the Overall Economy
The consequences of descending over the cliff will be complicated and far-reaching. According to the nonpartisan Congressional Budget Office, the GDP could contract by 0.5% in 2013. Approximately $600 billion would be removed from the economy, which is twice the projected growth in GDP this year, and more than $8 trillion would be lost over ten years. The unemployment rate could increase to more than 9% by the end of next year, and more than six million jobs would be lost. Other estimates indicate that the economy will slip back into recession and it could take most of the decade to recover. Most economists believe that the risks to the economy are indeed substantial. Just the uncertainty over what policy makers will ultimately do has already adversely affected the confidence of businesses, investors and consumers. As the battle rages on in Washington, consumers and businesses struggle to come to terms with these impacts and plan for what remains a very uncertain future.
If Congress and the president allow the tax increases to occur at the end of the year, it will cost the average American $3,500, according to a report from the nonpartisan Tax Policy Center. Taxes will go up for nearly 90% of Americans through a combination of higher rates on incomes and investments, and the loss of certain tax breaks. As a result of worries over what might happen, consumer confidence has declined. The predicted high unemployment levels resulting from both the cliff and the uncertainty surrounding it will negatively impact consumer spending as well. Increased taxes will mean that consumers have less to spend not only on goods and services, but on homes, which could derail the recovery in the housing market.
“Business owners who navigated through the Great Recession now face more uncharted territory created by ongoing uncertainty in Washington,” one banker said. “These owners know that potential federal government spending cuts and tax changes can create a ripple effect, hitting the pocketbooks of consumers and reducing spending that could hit small businesses hard.” Recent surveys of businesses about their investment and hiring plans and their feelings about the future have borne this out. For example, a Wells Fargo/Gallup poll found that small business owners are more pessimistic now than they’ve been at any time over the past two years. Uncertainty over the fiscal cliff is making business owners less likely to hire and invest, according to the quarterly survey. Nationwide, business investment in equipment and software – a measure of economic vitality in the corporate sector – stalled in the third quarter for the first time since early 2009. Executives say that they are slowing or delaying projects to protect corporate profits in the midst of reduced demand and rising uncertainty. The chief executives of more than 80 big-name companies have banded together to pressure Congress to reduce the deficit through tax-revenue increases as well as spending cuts. “There is no possible way; you can do the arithmetic a million different ways, to avoid raising taxes,” said one CEO. “You can’t tax your way to fix this problem, and you can’t cut entitlements enough to fix this problem.”
Only 16% of small business owners plan to add employees this year and the majority expects to hold off hiring into 2013, according to a quarterly survey by the Chamber of Commerce. Of the survey respondents, 62% said that the combination of the increase in taxes and spending cuts will negatively affect their business’s growth. The Chamber has called this uncertainty “the greatest threat to small businesses and out country’s economic recovery.” It added, “We can help reverse this downward trend by addressing the fiscal cliff, promoting sensible regulations and a clear road map for growth.” Another effect of the uncertainty is less business lending as banks become increasingly uneasy about the effects of the fiscal cliff and its potential to plunge the economy back into recession.
There Could Still Be Reason for Optimism
Even if the cliff isn’t avoided, the effects might be powerful, but gradual and, in some cases, reversible. “A relatively brief implementation of the tax and spending changes required by current law should cause little short-term damage to the economy as a whole,” said one economist. Even if an agreement isn’t reached by the end of the year, there would be time for Congress to strike a deal before the economy starts contracting. The Treasury Department has significant discretion over whether to adjust the withholding tax tables, meaning that it could choose to keep last year’s rates and avert much of the blow from the tax increases. Policy makers could also apply lower tax rates retroactively. Even more encouraging, if the cliff is avoided entirely, many CEOs at the country’s biggest companies believe a meaningful solution that includes tax reforms and better trade and energy policies, could lead to an economic boom.