The Fiscal Cliff

The United States Capitol is the meeting place of the United States Congress.

According to the Federal Reserve’s Survey of Consumer Finances, from 2007 to 2010, a typical US family lost 39 percent of its wealth – in 2007, the median family net worth was $126,400, in 2010, it was $77,300.

From 2000 to 2011, median income for working-age households fell from $63,535 to $55,640, a decline of $7,895, or 12.4 percent.

While income for the average American is falling, income for the rich has been increasing. According to the Center for Responsive Politics (CRP), a Washington watchdog, nearly half of the members of Congress are millionaires.

Increases in taxes and, to a lesser extent, reductions in spending, the infamous $600 billion “Fiscal Cliff” that’s looming in the new year, will reduce the US federal budget deficit by between 4 and 5.1 percent of Gross Domestic Product (GDP).

But at what cost?

The US Congressional Budget Office (CBO) analyzed two different scenarios if the fiscal cliff was left in place:

  • As measured by Fiscal Year – the combination of policies under current law 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.
  • If measured for calendar years 2012 and 2013, the amount of fiscal restraint is even larger. Most of the policy changes that reduce the deficit are scheduled to take effect at the beginning of calendar year 2013, so budget figures for fiscal year 2013—which begins in October 2012—reflect only about three-quarters of the effects of those policies on an annual basis. According to CBO’s estimates, the tax and spending policies that will be in effect under current law will reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013 (with the resulting economic feedback included, the reduction will be smaller).

Under those fiscal conditions, which will occur under current law, growth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5 percent, CBO expects—with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession.

According to the CBO if the fiscal cliff was removed, growth of real GDP in calendar year 2013 would be around 4.4 percent – a big difference.

By Rick Mills

Richard Mills, author and host of Ahead of the Herd, is an active investor and commentator in the junior resource sector. Rick’s work covers the spectrum of company analysis and macroeconomics.

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