Layman’s Terms: The Fiscal Cliff

Now that the elections are over, everyone in Washington is talking about The Fiscal Cliff. But what is this thing anyway? Where did it come from? How worried about it should we be? And what are our politicians going to do about it? Well, I will try to tell you, with helpful illustrations inspired by #StarWarsFiscalCliff (with a couple of Lord of the Rings quotes smuggled in).

A long time ago, in a budget far, far away, choices were made that brought us where we are today… Shall we begin?

Let’s start with our politicians in Washington. We ask for nice things without wanting to pay for them, and they give them to us because they want to re-elected. It’s a nice cycle.  Until the unpaid bills start to pile up and the “budget hawks” (a.k.a. party poopers) start to get concerned about the future. So they set dates for the parties to end. But whenever the date arrives, nobody wants to end the party just yet, so they all agree to continue the party for just one more year. After all, it will just cost a little bit more. Until the next date arrives, and they do it again.

For example. The “doc fix” is supposed to cut Medicare costs by knocking 30% off what the government pays Medicare doctors. But do we really have to cut that spending now? Those doctors won’t like that. How about next year? Meanwhile, the “Alternative Minimum Tax” is supposed to increase revenue by overriding the credits and deductions of rich taxpayers, but it’s not indexed to inflation, and every year it threatens to catch millions of “middle-class” families. Oops, better tweak that for next year, too.

Congress has been playing this game for years with relatively minor things like the doc fix and the AMT. But last decade, President Bush raised the stakes on this can-kicking game…

The “Bush tax cuts” were originally supposed to expire in 2010. Of course, when 2010 rolled around, what with a recession and all, nobody wanted those tax rates to go back up, so Congress kicked them along for a couple more years. Obama raised the stakes even further with a “temporary” 2% cut to the payroll tax that funds Social Security.

Now that we’ve gotten used to all these tax cuts, they’re all set to end in 2012! As if that wasn’t bad enough, several kinds of taxes to help pay for Obamacare start kicking in next year, too. Don’t forget about the relatively new extra-long unemployment benefits that are about to end, either. These expiring spending programs and tax cuts are a big part of The Fiscal Cliff.

But wait. There’s more.

All of this earlier tax cutting wouldn’t matter if we had cut spending to make up for it. But of course we didn’t do that. In fact, we increased spending even faster than we cut taxes. Some of it was on wars. Some of it was on Medicare, Medicaid, and Social Security. Some of it was on unemployment insurance and stimulus projects. All of it led to a ballooning national debt of over fifteen trillion dollars.

We all knew it was gonna have to have to stop eventually. For years, both parties had easily agreed to raise the government’s “debt ceiling” (a.k.a. credit limit) and borrow even more money from people and banks and governments around the world. But in 2011, the Tea-Party-infused Republicans tried to extract some concessions from Obama and the Democrats before they would go along in raising the ceiling again.

Nobody agreed on a plan; the Republicans didn’t want to increase taxes or cut defense spending, and the Democrats didn’t want to cut anything else. So they came up with a plan to trick themselves into coming up with a plan by setting up a default plan that was such a distasteful plan that they would have to come up with a better plan. This plan would cut hundreds of billions of dollars from defense spending AND from entitlements. This plan is called The Sequester.

But the trick didn’t work. Nobody agreed to a better plan, so those spending cuts are still set to kick in next year too. That is the rest of The Fiscal Cliff.

But wait. There’s more.

Since taxes are still down and spending is still way, way up, the Treasury is already getting close to last year’s new debt ceiling. Our government can’t afford to delay the Fiscal Cliff without extending the debt ceiling, and last year’s battle to raise it was intense enough without the cliff.

If we don’t really start getting this deficit in line, the ratings agencies are threatening to cut our credit rating some more, which – in theory – means investors could be less likely to keep lending us money. Ratings or no ratings, there’s a dangerous chance of that happening eventually anyway.

Of course, the deficit would improve a whole bunch if we go over the cliff, but the Congressional Budget Office says we could go into a recession if all these tax hikes and spending cuts kick in. (They also say this could lead to much better deficits and growth in a few years… but that’s a couple elections away, so who’s looking that far ahead?)

Somehow Congress has to figure out how to reduce the deficit enough to satisfy the global investors (and the conservatives worried about the growth of government), while also figuring how to not reduce the deficit so much that it hurts the short-term economy (and the liberals worried about the spending programs).

Since tax cuts were part of what led to this mess, it sorta makes sense that tax hikes should be part of the solution. But Republicans never really liked tax increases, and they definitely don’t like them now.

First, it doesn’t seem quite fair that almost all of the tax cuts of the last decade are on the table for elimination, while hardly any of the spending increases are, even though the spending was a bigger part of the problem. Second, Republicans are wary of repeating past deals where tax increases now were traded for spending cuts later – and later never came.

Third, they argue that – even though the economy soared in the 1990’s with the pre-Bush tax rates – there are a lot of people right now who would have a lot less money with those rates, which would hurt those people and all the businesses where they would spend that money. Finally, even if we just raised the rates on the richest folks, that would actually hurt some percentage of small businesses, and it wouldn’t solve the budget problems anyway – there just aren’t enough rich people to make a big dent in a budget hole this big.

Democrats like to bash Grover Norquist for getting a bunch of Republicans to sign pledges to oppose all tax increases of any kind. (This has led to philosophical political questions like, “Is letting a tax cut expire the same thing as supporting a tax hike?”) After the elections, however, Republican leaders started talking about actually accepting some revenue increases, perhaps only on the wealthy, as part of a compromise.

Democrats, on the other hand, are hesitant to cut spending. Medicare, Medicaid, and Social Security make up increasingly enormous chunks of the budget, but any attempts by Republicans to even tweak these programs is often met with charges that they want to “end [X program] as we know it” and kick grannies and poor people to the streets. Furthermore, proponents of Keynesian economics say since the economy is still bad and interest rates are low, we actually need to keep spending more money to stimulate things back into motion. Just like the Republicans and their tax increases, they’re worried about reducing money in the hands of millions of citizens.

So what happens next? No one really knows. As I’ve written before, I don’t think going over The Fiscal Cliff would be quite as terrifying as everyone’s making it out to be. Sure, it might cause some short-term pain, but short-term pain is what we’re going to have to swallow if we want to avoid long-term pain later. But I suspect Congress will figure out a way to avoid at least most of it. There are signs of politicians becoming more open to cutting spending – Senator Coburn’s “non-defense defense spending,” for example, but most of the overall conversation is still about the terror of “cuts” that are actually just “less of an increase than previously forecast.”

Full-on cliff jumping, full-off cliff avoidance, or anything in between – I feel like no result will surprise me. But I’ve been wrong before. Just remember, as this next long month and a half unfolds, no matter if it looks like things are succeeding or failing, it’s not over til it’s over…