What is the 'fiscal cliff,' and should Canadians be concerned?
Published Wednesday, November 7, 2012 1:57PM EST
Last Updated Thursday, November 8, 2012 2:16PM EST
The ominous term "fiscal cliff" has been making the rounds in the days surrounding the U.S. election, with everyone from economists to politicians to armchair pundits using the phrase to describe America's economic future.
But where does the expression come from and what does it really mean? And, perhaps most importantly, should we be scared?
What is the "fiscal cliff"?
CTV's Ottawa Bureau Chief Robert Fife explains that the fiscal cliff is "a sharp rise in taxes and deep cuts in federal spending" set to automatically take effect in January unless the U.S. Congress acts.
Put simply, the cliff is the result of a two-year-old stalemate between U.S. President Barack Obama's administration and Congress over government spending and tax cuts.
Unable to agree on a future plan -- and with Congress unwilling to raise the government's borrowing limit -- both sides agreed in August 2011 to a deadline of Dec. 31, 2012, after which automatic spending cuts would be triggered to deal with the growing U.S. debt load.
The fiscal cliff was intended to be a sort of failsafe device, pressuring lawmakers to come up with a plan or deal with the consequences. The bipartisan committee needed to find a way to cap U.S. spending over the next decade, while also coming up with $1.2 trillion in savings over the same period.
Amid a deeply polarized environment in Washington -- and with the presidential election looming -- the committee members have, perhaps not surprisingly, been unable to come up with a consensus.
As a result, the pre-set cuts are scheduled to start taking effect in January, unless policymakers can scramble to get a deal done in the next seven weeks, before the economy speeds off the so-called "cliff."
What will happen?
Unless a deal is reached by the end of this year, temporary tax cuts will expire, concurrent with the introduction of huge spending cuts.
Both ordinary citizens and big businesses will be hit with a combination of more taxes and less government support for the struggling economy at the same time.
The tax increases and spending cuts add up to more than US$600 billion, and are expected to have an immediate and catastrophic effect on the U.S. economy -- and by extension, any economies that rely heavily on it, such as Canada.
"If the U.S. economy weakens and weakens substantially, then it will have a knock-on effect almost immediately on the Canadian economy," said economist Craig Alexander.
Buried within the $600 billion in cuts and taxes are reductions to the U.S. defence budget, changes to Medicare allowances and higher personal taxes. Even some child support and income credits for the poorest Americans are set to end.
According to some predictions, the term "cliff" is overblown and somewhat sensational, because the changes will be introduced over the course of 2013, not all at once.
Still, the predictions are almost all grim.
Economists have generally outlined a drop to the U.S. GDP of between four to six per cent. And unemployment is expected to rise by an estimated two percentage points, to sit around 10 per cent. That translates into an additional 2.8 million Americans out of work.
How did the U.S. get here?
Obama has often talked about the economic challenges he inherited when first elected to office in 2008. The fiscal cliff is one of those, dating back to his predecessor George W. Bush.
In 2001, the Bush administration was trying to push through a package of tax cuts worth around $1.7 billion. Bush wasn't able to secure the support of a majority of Congress and, as a result, the cuts went through with a modified expiry date of 2011.
Obama added his own tax changes to the legislation in hopes of bolstering the struggling economy, and a deal was reached with Congress to extend that deadline by two years.
That latest deadline is now nearly up.
Why does it matter?
In October, the International Monetary Fund released a gloomy outlook for the global economy, saying in the previous few months global growth prospects were down sharply. Among advanced economies, the IMF said, growth was expected to hit 1.3 per cent in 2012, compared with 1.6 per cent in 2011 and a full 3 per cent in 2010.
If the U.S. can't reach a deal the stave off the fiscal cliff, the IMF warned, the world’s economic outlook could become even worse.
"The IMF said that its forecast rested on two crucial policy assumptions," a statement from the IMF reads. "That European policymakers get the Euro area crisis under control and that policymakers in the United States take action to tackle the 'fiscal cliff' and do not allow automatic tax increases and spending cuts to take effect.
"Failure to act on either issue would make growth prospects far worse."
Such an outcome would have a direct effect on all economies that do business with the U.S., said Liberal interim leader Bob Rae, especially Canada, as America’s biggest trading partner.
With Obama's election victory Tuesday, Rae said it's time to put partisanship aside and focus on getting the economy on track.
"The key thing is for the president and Congress to agree on a realistic strategy to deal with the overall economic situation in the United States," he said.
And Finance Minister Jim Flaherty warned Wednesday that failure to reach a deal before Jan. 1 will plunge the United States into a recession quickly, with Canada to follow shortly afterward.