What Exactly is the ‘Fiscal Cliff’?

by Steven Schou, CFP, CFO, Senior Partner, Investment Advisor Representative
(Originally appeared as a guest column in the Rockford Register Star, Dec. 23, 2012)

According to Thomas Kenny, About.com, among the laws to change at midnight on December 31, 2012, are the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax, the end of the tax cuts from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. According to Barron’s, over 1,000 government programs, including defense and Medicare are in line for “deep automatic cuts.”

In 2010, a commission (The National Commission on Fiscal Responsibility and Reform – NCFRR) was established by President Obama from both parties. “The moment of truth” was in the reports’ name, dated December 2010. The President gave them a two-part mission, according to the report, to bring the budget into primary balance (balance excluding interest costs) in 2015, and to meaningfully improve the long run fiscal outlook.

The challenge is clear and inescapable: America cannot be great if we go broke! Businesses will not be able to grow and create jobs, and workers will not be able to compete successfully for the jobs of the future without a plan to get the crushing debt off of American’s backs. Since the economic downturn, families across America have had to tighten their belts by cutting expenses and reducing their debt. As Americans, should we not expect the leaders of this great country to do the same? Neither party can fix the financial mess on their own and both parties have a responsibility to do their part.

According to the report, our Nation is on an unsustainable fiscal path. Since the last time our budget was balanced in 2001, the federal debt has increased, dramatically rising from 33% of GDP (Gross Domestic Product) to 62% of GDP in 2010. The escalation was driven in large part by two wars and too many fiscally irresponsible policies, along with a deep recession. We have arrived at the moment of truth, and neither political party is without blame. The problem is real, and the solution will be painful.

The commission proposed a six-part plan to put America back on the path to fiscal health, promote economic growth, and protect the most vulnerable among us. Taken as a whole, the plan would:

  • Achieve nearly $4 Trillion in deficit reduction through 2020, more than any effort in the nation’s history.
  • Reduce the deficit to 2.3% of GDP for 2015 (2.4% excluding Social Security reform), exceeding President’s goal of primary balance (about 3% of GDP).*
  • Sharply reduce tax notes, abolish the AMT, and cut back door spending in the tax code.
    Cap revenue at 21% of GDP, get spending below 22% and eventually to 21%.
  • Ensure lasting Social Security solvency, prevent the projected 22% cuts to come in 2037, reduce elderly poverty, and distribute the burden fairly.
  • Stabilize debt by 2014 and reduce debt to 60% of GDP by 2023 and 40% by 2035.

Unfortunately, the proposals of the committee fell short of the 14 vote super majority to force adoption, with an 11 to 7 vote.

Politics aside, what’s best for the American public should be the number one priority.

If you would like to obtain a copy of the NCFRR report go to: fiscalcommission.gov.

*Note that increases in this deficit level as compared to the Co-Chairs’ November 10, 2010, draft do not reflect major policy changes, but rather baseline changes to more honestly (and conservatively) account for the costs of the conflicts in Iraq and Afghanistan

References: What is the Fiscal Cliff? By Thomas Kenny, About.com Bonds, About.com Guide 2012; and, The National Commission on Fiscal Responsibility and Reform, The Moment of Truth, The White House, December 2010.

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Steven (Steve) Schou
Senior Director
Investment Advisor Representative
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Steve serves as Chief Financial Officer, and is a co-owner of Klaas Financial, inc., and its’ subsidiary companies. Steve has worked in the financial services industry since 1979 and obtained his Certified Financial Planner certification in 1994. Steve is a member of the Financial Planning Association and locally on the executive board of Patriot’s Gateway Center.