What exactly IS the Fiscal Cliff?

By Amy Payne

The Heritage Foundation

With just a few weeks left in 2012, all eyes in Washington are on Capitol Hill and the “fiscal cliff”negotiations. As usual, Congress and the President are taking highly contentious issues down to the wire before cutting a deal—never a situation that ends well for taxpayers.

Federal Reserve Chairman Ben Bernanke coined the term “fiscal cliff” while urging Congress to avoid a steep dropoff for the economy at the end of the year thanks to tax increases and automatic budget cuts.

There is no agreement right now on how to avoid it, however. When Treasury Secretary Tim Geithner presented the White House’s plan to House Speaker John Boehner (R-OH) last week, Boehner said, “You can’t be serious.” Thus far, President Obama’s answer to the fiscal cliff is a proposed $1.6 trillion in tax hikes plus new stimulus spending—and expanded power for himself to raise the debt ceiling without congressional approval. He suggests only magnifying the policies that brought us to the fiscal cliff in the first place.

Heritage’s Romina Boccia, James Sherk, and Katie Tubb have explained “What’s in the Fiscal Cliff?” and recommended solutions to several of the immediate problems. They note that American individuals, families, businesses, and the military will all be harmed if the nation goes “off the cliff,” so to speak, or if a bad deal is done in Washington. Here are some of the major components of the fiscal cliff.

Tax Hikes

Tax hikes are the centerpiece of the problem, as the largest tax increase in American history is scheduled to kick in on January 1. This tax increase has been dubbed “Taxmageddon.” The authors break down its parts:

Most of this massive tax increase stems from the expiration of the 2001 and 2003 tax cuts implemented under President George W. Bush. There is also the payroll tax cut, the alternative minimum tax patch, and a host of other policies that expire at year’s end. In addition, five of the 18 tax increases built into Obamacare are scheduled to go into effect. Families will bear the brunt of this tax increase among American households, with an average increase of over $4,100 in taxes.

Raising taxes on upper-income earners would affect the nation’s most robust job creators among small businesses. The effects of this would be devastating to the economy. The Congressional Budget Office is already forecasting another recession could hit in 2013. Congress should extend current tax policies for all Americans.

Defense Cuts

The fiscal cliff includes required cuts to defense spending. The cuts to America’s defenses known as “sequestration” were never supposed to happen. They are kicking in because a congressional “super committee” failed to reach a deal on spending cuts after last summer’s deal to raise the debt ceiling. Now these cuts are poised to gut military readiness because of a previous Washington negotiation gone wrong.

A Continual Medicare Problem

Medicare’s finances are in grave trouble. Years ago, Congress decided to reduce Medicare spending by paying doctors less to treat Medicare patients. That was an unsustainable idea—and Congress realized it later. Every year, instead of allowing the automatic cuts to doctor pay, Congress has made a temporary patch called the “doc fix” that keeps payments coming—which helps delay substantial Medicare reform. Now, “Unless Congress patches together another doc fix agreement before December 31, physicians will see a 27 percent decrease in pay, a situation that will make it unaffordable for many doctors to continue accepting Medicare patients.”

After preventing the cuts once again (which is likely to happen in any deal), the new Congress should pursue real Medicare reform that would permanently eliminate this problem.

Extending Unemployment Benefits

Federal funding for extended unemployment benefits is also set to expire at the end of this year. Extending these benefits again is one of the issues on the fiscal cliff bargaining table.

Although the average length of unemployment is 40 weeks, these benefits are available for 73 weeks. In a rough economy, many people need unemployment benefits. But “extending UI also increases unemployment and can hurt those it is meant to help. Extending benefits for too long encourages the unemployed to postpone job searches or hold out for something that may not be attainable.” While a deal is likely to extend these benefits, Congress should set the benefits at a more realistic 52 or 60 weeks.

This is a complex set of problems that should not be glossed over in a hasty deal.

Read more about The Heritage Foundation’s recommendations for each of these parts of the fiscal cliff.