2012 was a long and important year for America. The country was successfully recovering from the Great Recession, and presidential elections loomed on the horizon with a notion of new hope for the people. But on January 1, 2013, the United States found itself on the verge of another big recession. It nearly went over the fiscal cliff.
A Cliff in Name Only
January 1 was scheduled to see several tax cuts expire, leading to higher taxes and reduced consumer spending. Plus, sequestration would drastically cut government spending on discretionary programs.
Consumer spending, tax revenues, and government spending are the engines that drive GDP and keep the nation’s economy healthy. Due to previously passed legislation, a lot of economic changes were going to happen simultaneously, possibly sending the United States into another great recession. That, experts say, could have led to more than three million people losing their jobs. The rest would be paying higher taxes and making fewer purchases to drive the nation’s economic growth.
It is still unclear who exactly coined the fiscal cliff definition and applied it to the impending financial catastrophe. Some say it originated in 1989 when St. Louis Post-Dispatch reporter Safir Ahmed used the term in an article about education funding. The term started appearing in print more often in 2011, when it was used in reference to expiring tax cuts. Federal Reserve chair Ben Bernanke used the term in early 2012 in warnings about the financial disaster that loomed on the horizon. So the definition of the fiscal cliff is a crisis driven by tax cuts and government spending cuts all expiring at the same time.
The name evokes imagery of falling over a cliff. That’s appropriate, as the economy was figuratively teetering on the edge of a cliff. Experts said it was poised to suffer a massive fall, the worst in 60 years or more. Some analysts suggested renaming the impending downturn a “fiscal slope” or “fiscal hill,” suggesting that the effects could be gradual, not immediate.
No matter what they called it, there’s no denying it was unwanted.
The Cause of the Fiscal Crisis
There were numerous causes for the crisis that was narrowly averted. The short version is that Bush-era tax cuts were all scheduled to expire on the same day – which happened to be the day.
For a clearer look, it would be helpful to travel back in time, back to 2001.
The Economic Growth and Tax Relief Reconciliation Act of 2001
One of the major tax cuts signed by President George W. Bush was passed just a few months after he took office. The cuts fueled a further fiscal deficit increase. One of the two Bush tax cuts, later known as EGGSTRA, reduced individual income tax rates by up to 10%. It was designed to reduce tax rates further in 2006.
The Jobs and Growth Tax Relief Reconciliation Act
Another major tax cut, JGTRRA, was introduced in the middle of 2003 as a way to end the 2001 recession. It is credited with boosting economic growth by 3.8% in 2004. The act significantly reduced long-term capital gains tax rates. In just five years the act zeroed tax rates for a group that previously paid 10-15%. Dividend tax rates became equal to long-term tax rates, and companies started investing in stocks that paid dividends. Analysts say the act should have expired in 2004 or 2005, once the recession’s damage was ameliorated, but it was set to last until 2010. Ultimately, Congress chose to extend it.
Obama’s 2010 Tax Cut
JGTRRA was extended in 2010 during President Obama’s presidency. The 2010 legislation was a massive $858 billion deal that cut payroll taxes by two percent and extended unemployment benefits for another year. It also included $55 billion in tax cuts for industry, an extension of the college-tuition tax credit, and an increase in workers’ spendable income of $120 million. The legislation also reinstated the inheritance tax, a 35% tax that applied to individuals with residences worth $5 million and families with estates worth more than $10 million.
The Alternative Minimum Tax
Obama was determined to reduce the US deficit, and so he tinkered with the Alternative Minimum Tax too. Originally intended to catch tax evaders from the highest-grossing class, it had a major flaw – it didn’t take inflation into account. This face could have seen 21 million or more workers earning under $50,000 suffer tax increases of up to $3,700.
The Budget Control Act of 2011
A set of complex mechanisms was enacted in early August of 2011, including a federal debt ceiling. Billed as the Budget Control Act, this statute raised the debt ceiling to $400 billion, with the option for the president to raise it by $500 billion and even by another $1.5 trillion. There were further deficit reductions, the most notable being $917 billion of cuts over 10 years, with $21 billion slated to take effect during the 2012 fiscal year. The most important part of the act was the requirement for Congress to create a deficit reduction plan that detailed at least $1.2 trillion in spending cuts.
What the Fiscal Cliff in 2013 Could Have Looked Like
The fiscal cliff could have seen America fall into another recession. The tax cuts and budget-control laws were all set to end on the same date. Had that actually happened, the sudden shock to the economy would have been $607 billion.