The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts

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But it goes deeper than that. If employers are uncertain about the state of the economy in general, they tend to lack confidence that there will be a demand for their products in the future. As a result, they may defer hiring or increasing wages, which adds to unemployment and further dilutes the economy.

Q: Interesting.

Diving Off the Fiscal Cliff: An Economy on the Rocks

If we only extend the cuts for the lower and middle classes, would the boon to the economy be softened? The reasons kind of make sense: if we extend the cuts for the nation's wealthiest, those taxpayers will obviously have more cash. Clearly, this can, and likely will, be spun in the favor of both parties. Republicans will argue that since there is virtually no difference in the impact on the economy, the President should extend the cuts for all taxpayers.

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The Democrats, of course, will maintain that the numbers support their position that the President can increase the tax on the nation's rich and collect the related additional tax revenue, all without having a detrimental effect on economic growth. Q: OK, so what if the government goes all in and gets rid of the spending cuts, extends all the Bush tax cuts, and patches the AMT? What would that do for our economy in ?

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The upside, of course, is the immediate impact on the economy. These changes would grow GDP by 2. Q: Got it. If we want to remain on the path of economic growth, we've got to get rid of the spending cuts and tax increases and stay the recent course. Can you explain? If this were to occur, while there may be a short-term recession, after economic growth will pick up and the labor market will improve. As a result, the unemployment rate will drop to 5.

What happens to the economy if we go over the cliff?

This is, again, all according to the CBO. A: I'm no economist, but it certainly appears so, doesn't it? The question becomes, are we ready to pull off the band-aid all at once and deal with the pain, or do we want to drag out the process over a period of years in hopes of evening out the discomfort?

If we go over the cliff and get on the right track in terms of trimming our deficit, we'll head back into a recession in In the alternative, if we avoid the fiscal cliff we may preserve our recent economic growth, but by failing to address the government's bigger problem -- it's bloated deficit and outstanding debt -- we may end up worse off ten years from now. A: I honestly don't know, and even if I told you my recommendation, you probably shouldn't listen to it anyway. I can tell you this though: there is no quick fix or magic bullet.

As a country, we probably need to take a hard look at some of our policies and search for a more sustainable path. Whether it's raising taxes, reducing benefits for the elderly or decreasing military spending, some hard, unpopular decisions are going to have to be made. The more interesting aspect is to what extent a divided Congress will be willing to attack the issue and reach a meaningful agreement before year-end. The Republican side is already pushing for much-needed tax reform resulting from an overhaul of the Code.

Obama has not ruled out a compromise that would limit deductions as well as setting the top rate above 35 percent but below What now? Might they really reach an impasse? No one knows. Despite market jitters about that outcome, Democrats suggest that they are willing to let Jan.

That could simply be bravado, to make Republicans blink. Is there a best-case outcome here? Many budget experts and economists are hoping for a two-part deal. The first part would extend many of the tax cuts and repeal the automatic spending cuts to avert the changes scheduled after Jan.

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But it would be contingent on the second part: a framework for reducing projected long-term deficits by overhauling both the tax code — to raise revenues — and entitlement programs — chiefly Medicare and Medicaid , whose rising costs in an aging population are unsustainable. Those overhauls would preoccupy Mr. Obama and Congress through and perhaps If they failed to do so, presumably other automatic changes might be in store as an enforcement action — setting up yet another looming deadline. Tell us what you think. Please upgrade your browser. See next articles.

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CBO Economy Shocker: US Faces Fiscal Cliff and Certain Recession

Of course, it remains to be seen how lawmakers plan to replace the sequester. Assuming that they replace it with cuts that take place beyond , the fiscal cliff related drag would be further reduced to 0. There are a few things to note about these calculations. That cliff would be much more mild overall than this cliff, but would still have an effect in The second is that the 1.

Finally, this does not account for any increased or reduced uncertainty as a result of the deal or effects related to the failure to adequately tackle our long-term debt problem. In short, out of a 2.