By Nick Markola CIMA®
Year 2012 is slowly drawing to an end. The media appears to be mesmerized with the Fiscal Cliff which is set to take place on the first day of the new year, and rightfully so. Unless Washington politicians from both parties come up with an agreement, consequences could be murky. What is the fiscal cliff? Many investors are unclear about the repercussions if the United States were to go over the cliff and what that would do to the country, the economy and their investments. Media outlets are busy pointing out that if the US were to go over the Fiscal Cliff, it could be devastating for all.
What is the Fiscal Cliff? It is a collection of laws currently on the books, that if unchanged, could result in tax increases, spending cuts and a corresponding reduction in the budget deficit beginning in 2013. These laws include tax increases due to the expiration of the Bush era tax cuts and spending cuts under the Budget Control Act of 2011. Such tax increases will affect the rich the most but they are expected to impact a very broad range of taxpayers. The Budget Control Act of 2011 was passed after the two parties could not agree on how to control the US deficit. The thought was that deep cuts would be unacceptable to democrats while sharp tax increases would be objected by republicans thus forcing both parties to negotiate a deficit solution. The year-over-year changes for fiscal years 2012–2013 include a 19.63% increase in tax revenue and 0.25% reduction in spending. Some major programs, such as Social Security, Medicaid, federal and military pay and pensions as well as veterans’ benefits, are exempted from the spending cuts. Spending for federal agencies and cabinet departments would be reduced through broad based cuts. In terms of cuts, cuts to the US military are mostly talked about and are referred to as budget sequestration.
The Great Recession of 2008/2009 had a profound impact on the US and the world. It also impacted severely people from Wall Street to Main Street. Since the Great Recession, the US has turned the corner and had worked on the recovery although the recovery has been slow. If the US goes over the Fiscal Cliff, there is a high probability that the current slow US growth will slow further and the country may enter into yet another recession. The reasons for such a potential negative move are the events that will be triggered if no agreement is reached. On the spending side, cuts to the military and other programs will have an adverse impact on the economy as there will be less money to be spent across the board. In terms of raising taxes, that term seems to be banned in Washington and the term of the day is raising revenues. Raising revenues is nothing else but tax increase. Increasing taxes during the time when the economy is teetering on the brink and growing at an anemic rate may not be the most prudent step forward.
The US fiscal house is not in order and it may be helpful to simplify the numbers. We are hearing about billion dollar deficits or 16 trillion dollar debt, but that may be hard for some to relate to. A trillion is an enormous number. For example, if a million dollars was spent every day (not every year) since the day Jesus was born about two thousand years ago, by today that figure would not reach a trillion. Let’s assume the US is an average household, or it could be your household. This household takes in net $26,000 in income from various sources on an annual basis. The same household is also accustomed to a certain lifestyle and luxuries that it doesn’t want to part ways with. The lifestyle and all expenditures cost the household $37,000. Therefore on annual basis, this average household takes in $26,000, spends $37,000 and has a deficit of $11,000. It does not take a genius from a prestigious Albanian university to realize that this is not sustainable on long term basis to spend more than what you take in. This average household has had the bad habit of spending more in the past and financed its spending by borrowing on the credit card. Now the debt on the family credit card has surpassed $160,000. By any measure, this is a family on shaky financial grounds with such large debt and annual deficit. An average person understands that they cannot survive for long without making some real changes if their annual income is $26,000, annual expenditures are $37,000 and their total debt exceeds $160,000 with no assets.
The average household in the above example is unfortunately the United States of America, the leader of the free world and the economic powerhouse of the 20th century. Take the numbers in the above example and add eight zeros and the financial picture of the US emerges with a $16 trillion current debt, $3.7 trillion annual budget (expenditures) and $2.6 trillion annual revenues (tax collections). Going over the Fiscal Cliff could be very painful and impact many adversely. But as the numbers above show, the financial position is challenging. Some tough choices need to be made and the road ahead could be very bumpy. On the other side, the US is still the global economic powerhouse. Innovation still lives in the US and developments in the energy sector are very promising. With the discovery of vast natural gas reserves and oils shales, we could be on a short path to energy independence and turning the US to a low cost manufactures due to potential inexpensive energy. Until then, the hope is that politicians will make the right decisions and lead us through the bumps.
* The writer is the Co-Founder of APEN and the Treasurer of the Mark Gjonaj 2012 Campaign