There is a new kind of economic disorder in the United States taking roots in their fiscal policy. It has emerged in the system foreshadowing an economic apocalypse of the US economy, and is known as the Fiscal Cliff.

The implication of the Fiscal Cliff, if left unchecked, will be devastating in nature and highly toxic for the US and global economic stability. The term ‘Fiscal Cliff’ refers to a package of tax increases and spending cuts that may take place due to the expiration of certain laws dealing with tax code and state spending.

In other words, it refers to a stage where economic fortunes may slip down under a deep no-growth trajectory because of laws which will get activated automatically in January.

According to the BBC, on 31 December, a raft of temporary tax cuts is due to expire just as huge automatic spending cuts are introduced. Individuals and companies will be hit simultaneously with tax rises and reductions in government contracts, benefits and support.

BBC further says that some $607 billion of cuts and tax rises are planned, including reductions in the defense budget, the end of an employee tax holiday, changes to Medicare allowances and higher personal taxes.

The ideology of both Republicans and Democrats is asymmetrical when it comes to resolution of the fiscal mess: President Obama proposes a tax increase for the households that earn more than $250,000 per year, but Republicans tend to repeatedly torpedo that proposal. Republicans seem to favor a “no tax rate increase policy,” with some adjustments and corrections in spending programs.

According to Boston.com, Republican Senator Lindsay Graham of South Carolina said “No republican will vote for higher tax rates… We will generate revenue from eliminating deductions and loopholes, but we will insist our Democratic friends reform entitlements – something we’ve never done, and that’s where the big money is at.”

According to CBS News, about $1.2 trillion in federal spending cuts are scheduled to take place next year, and some state-run health care programs for the elderly, such as Medicare, will be affected by a 2 percent reduction in payments.

There come questions about how to jump-start job creation and fuel economic growth while still slashing away at federal deficits. Tax hikes to annihilate deficits may plunder the economy itself; tax increase arrests spending and investment but can positively correlate with a deficit reduction scheme.

Ironically, it all depends on how much importance we attach to ballooning deficits and interest service and how we see growth. If spending is slashed through different programs, like Medicare, it will adversely affect savings among the elderly as it will wipe-out state help, leaving them to rely on whatever means they have.

On the other hand, even if Bush-Era Tax Cuts were to be extended for the next two years, will they be helpful in opening the door for faster economic growth? For the last few years Bush-era tax cuts were in place in the economy along with the low interest rate policy adopted by the US Federal Reserve, but the economy is still coughing. What is needed is to increase taxes if deficit reduction is primary for the economy.

The argument is that it might drag the economy back into a recession, but again a question arises. Are these tax-cuts helpful in getting the economy back on a stable surface?

There is no magic wand that can drain out the federal deficits and growth rate with the same pattern of spending and bush-era tax cuts in place.

Ultimately what can be done to avert the crisis, to shield the US economy falling over the cliff? The resolution is in striking a deal that limits spending (to some extent) and increasing tax rates on households earning more than $398,350. Spending on defense should be lowered dramatically; further laws with sunset provisions must be avoided.

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About the author

Muhammed Faraaz
Post-graduate in Economics from India, unfolding complexities and policies. Proponent of Classical Economics.

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