At the start of 2013, the USA faces a ‘fiscal cliff’. By this is meant that, without agreement by Congress on new fiscal measures, the USA will be forced into tax rises and expenditure cuts of around $650 billion (over 4% of GDP). This would probably push the economy straight back into recession. This in turn would have a serious dampening effect on the global economy.
But why would fiscal policy be automatically tightened? The first reason is that tax cuts given under the George W. Bush administration during 2001–3 (largely to the rich) are due to expire. Also a temporary cut in payroll taxes and an increase in tax credits given by President Obama are also due to end. These tax increases would form the bulk of the tightening. The average US household would pay an extra $3500 in taxes, reducing after-tax income by around 6%.
The second reason is that various government expenditure programmes are scheduled to be reduced. These reductions in expenditure amount to around $110 billion.
It is likely, however, that Congress will agree to delay or limit the tax increases or expenditure cuts; politicians on both sides want to avoid sending the economy back into recession. But what the agreement will be is not at all clear at this stage.
Republicans are taking a tougher line than Democrats on cutting the budget deficit; they are calling for considerably less restraint in implementing the government expenditure cuts. On the other hand, they are likely to be less willing to raise taxes.
But unless something is done, the consequences for 2013 could be dire. The fiscal cliff edge rapidly approaches.
Nearly 90 percent of Americans would see taxes rise if ‘fiscal cliff’ hits Washington Post, Lori Montgomery (1/10/12)
Fiscal cliff a serious threat, but unlikely CNN Money, Chris Isidore (1/10/12)
“Fiscal cliff” fears may impede faster job growth Chicago Tribute, Lucia Mutikani (1/10/12)
Avert Fiscal Cliff With Entitlement Cuts, Tax Increases Bloomberg (2/10/12)
‘Fiscal cliff’ to hit 90% of US families Financial Times, James Politi (1/10/12)
Investors don’t want the US to fall off the fiscal cliff The Telegraph, Tom Stevenson (22/9/12)
Gauging the fiscal cliff BBC News, Stephanie Flanders (27/9/12)
The US fiscal cliff – and the fiscal chasm BBC News, Stephanie Flanders (2/10/12)
US fiscal cliff threat fails to galvanise policymakers Guardian Economics blog, Mohamed el-Erian (1/10/12)
Multiplying Europe’s fiscal suicide (technical) The Telegraph, Ambrose Evans-Pritchard (1/10/12)
Q&A: The US fiscal cliff BBC News (7/11/12)
US election: Four more years… of what? BBC News, Stephanie Flanders (7/11/12)
United States fiscal cliff Wikipedia
- Explain what is meant by the ‘fiscal cliff’ and what is its magnitude.
- What would be the multiplier implications of the USA ‘falling off the cliff’ both for the USA and for the rest of the world?
- What factors determine the size of the government expenditure and tax multipliers? What would be the problems of (a) underestimating and (b) overestimating the size of these multipliers?
- How can a fiscal stimulus be reconciled with a policy of reducing the size of the budget deficit as a proportion of GDP over the longer term?
- In what ways can the actions of Democrats and Republicans be seen as game playing? What are the possible payoffs and risks to both sides?
- Is relying on export growth to bring the world economy out of recession a zero sum game?
- Explain which is likely to be more effective in stimulating short- and medium-term economic growth in the USA: fiscal policy or monetary policy.