Fiscal Cliff Ahead: What it May Mean

Over the past few weeks I've been hearing the term "fiscal cliff" by the TV talking heads.  Some do a better job explaining what they are referring to than others.  So if you're confused or unsure of what they are referring to listen up. 

"Fiscal cliff" is the term used to describe a series of laws that are all expiring at the end of 2012 or are being implemented at the very beginning of 2013 that will have a dramatic adverse impact on the U.S. economy.  Among the laws set to change are:

• The end of last year's temporary 2% payroll tax cut and extended unemployment benefits
• The end of specific tax breaks for businesses
• The end of the Bush era tax cuts
• The start of new taxes related to Obamacare
• The automatic spending cuts resulting from the supercommittee not agreeing to a compromise budget deal 

Without congressional action, up to $600 billion of expiring tax cuts, new taxes and automatic spending cuts are set to take effect.  Some experts predict that if these tax hikes and spending cuts happen all at once the economy would experience a significant slow down throwing the U.S. economy back into a recession.  So the threat to our economy is very real.  

So what is the likelihood that Congress and the president will act responsibly and come up with an acceptable compromise to all parties?  So far Republicans and Democrats in Congress have shown little sign of agreeing on anything except that the other side is to blame for their failure to compromise.  I see four possible scenarios:

Scenario 1: Delay

A likely scenario is that Congress and the president agree to push the issue into 2013 after the presidential inauguration and the new Congress arrives.  If that happens, the tax cuts would continue, the tax increases won't take affect, and the spending cuts will be delayed.  The big problem with this scenario is postponing these difficult decisions continues market uncertainty.  This puts the business community on hold, delaying investments in capital expenditures and the hiring of additional employees.  I think this is more likely if Romney wins in November. 

Scenario 2: Modest Compromise

The lame duck Congress and the president reach compromises on some tax and spending decisions.  I see a scenario where both Republicans and Democrats cave completely on the automatic spending cuts to defense and domestic spending.  I believe this scenario is more likely if Obama wins the election. 

Scenario 3: Over the Cliff

Congress and President Obama fail to reach any compromise whatsoever resulting in the economy going over the cliff into the abyss below.  I would hope that there are reasonable politicians from both parties that could see that this scenario is not in anyone's best interest. 

Scenario 4: The Grand Bargain

In this scenario, Congress and the president reach a comprehensive deal addressing tax, spending and fiscal issues.  The new agreement not only answers the immediate issues facing the country but the agreement also tackles these major issues for the next 5 to 10 years.  Unfortunately I think you have to live in la-la land to believe this scenario. 

So which scenario is most likely?  It's anyone's guess and certainly there could be other scenarios not presented.  I'm personally very discouraged with the lack of leadership in Washington from both sides of the isle.  And yet the alternative of doing nothing is so potentially cataclysmic that I have to believe that even this Congress will do something.  They just have to.  My vote is for Scenario 1.  Any bets?  

Sources: Fiscal cliff ahead: What it may mean, Fidelity Investments, June 28, 2012; Give us a brake, The Economist, October 6, 2012; What is the Fiscal Cliff?, Thomas Kenny, About.com.