The $7 trillion fiscal cliff

@CNNMoney April 30, 2012: 7:14 AM ET

NEW YORK (CNNMoney) -- Congress has invented a new extreme sport: Skating on the edge of a $7 trillion fiscal cliff.

That's the magnitude of tax increases and spending cuts that will start to hit the economy on Jan. 1, 2013, unless Congress acts.

And how Congress navigates that fiscal cliff will affect economic growth, Americans' wallets and the country's fiscal outlook. (Fiscal cliff: What should Congress do?)

"There is about $7 trillion there that ... could be taken out of the economy in a really stupid way that would likely push us into a recession immediately," said Maya MacGuineas, president of the Committee for a Responsible Federal Budget.

Indeed, economist Mark Zandi estimates that inaction by Congress could chop 3 percentage points off inflation-adjusted economic growth in 2013. In that scenario, he estimates the economy would stop growing.

On the other hand, simply extending all the expiring tax policies and canceling the spending cuts could add more than $7 trillion to the country's debt over 10 years. While that would boost growth in 2013, it would hurt the economy by the end of the decade.

Of course, anyone with a modicum of common sense would prefer a more finessed approach. "We have to come up with a compromise to thread this needle," said MacGuineas, who appeared at a recent conference.

But few observers think that will happen anytime soon.

Instead, most believe that lawmakers will postpone taking up the issue until after the Nov. 6 elections, giving themselves less than eight weeks to address what may be the largest single package of fiscal issues they've ever tackled.

How did it come to this?

Bush tax cuts and AMT fix: In 2001, 2003 and 2006, Congress passed a series of tax measures known as the Bush tax cuts. They reduced income and investment tax rates; shrank the estate tax bite; and expanded a number of breaks for low- and middle-income families.

Meanwhile, Congress regularly extended the temporary "patch" to the Alternative Minimum Tax so that more than 20 million families wouldn't get trapped by the so-called wealth tax.

If the Bush tax cuts and AMT patch were allowed to expire as scheduled, households would be hit with an average tax increase of $3,000, the Tax Policy Center estimates. The lowest 20% of households with a tax increase would pay $512 more on average, while the top rung would pay $12,819 more.

If both policies are extended, most people wouldn't notice any changes in the near-term. But the federal budget would take a long-term hit if lawmakers didn't enact offsetting policies to pay for the extensions, which the Congressional Budget Office estimates would cost $5.35 trillion over 10 years, including debt service.

If the measures expire, the country's medium-term debt problem could be greatly reduced. But it would be a blunt strategy.

Far better would be "to raise revenue by simplifying and cleaning out tax breaks ... rather than adding higher rates on a top of a code that is in many ways broken," a report from MacGuineas' CRFB said.

Big spending cuts: As part of the debt ceiling deal Congress struck last summer, nearly $1 trillion in spending cuts over nine years are set to take effect starting next year.

In addition to cutting defense by 10%, the so-called sequester will also cut about 8% from non-defense discretionary programs. Appropriators haven't decided how much to cut specific programs. But individuals are bound to be affected, since non-defense spending involves everything from education to law enforcement to housing assistance and national parks.

Deficits would be reduced by $1.2 trillion over 10 years, including debt service, if the cuts -- or a replacement Congress agrees on -- take effect as scheduled.

Doc fix: Reimbursements to Medicare physicians will be cut by close to 30% next year unless lawmakers prevent it. They've done so for years under the so-called doc fix and are likely to do so again.

The cost of the doc fix is roughly $30 billion a year.

Tax extenders: Congress regularly extends more than 50 "temporary" tax breaks for businesses and individuals.

The so-called extenders include one that lets businesses accelerate their depreciation for equipment purchases and another that gives individuals the option to deduct state sales taxes on their federal returns.

The economic value of keeping all the extenders is debatable. Tax experts argue that many should be ditched -- and those that are kept should be made permanent.

Temporarily extending them can cost anywhere from $25 billion to $35 billion a year.

Payroll tax cut: The usual Social Security tax rate paid by workers is 6.2% on the first $110,100 in wages (up from $106,800 last year). But for the past two years it's been 4.2%.

Once the payroll tax holiday expires, workers making $50,000 will again have to pay an additional $1,000 into the system next year -- or about $83 a month. Those making $100,000 would pay double that.

The cost of extending the payroll tax cut approaches $115 billion a year.

While it seems unlikely that lawmakers would extend it again, if they do, they will add to what Uncle Sam owes Social Security.

Why? Because Congress has decided that the Social Security trust fund shouldn't take the hit from the payroll tax cut; rather, general revenue should be used to compensate the fund.

Unemployment benefits: Congress for the past few years has authorized special help for the jobless -- a higher maximum number of weeks that the unemployed can collect benefits. The latest extension expires at the end of the year.

It's not clear if lawmakers will extend the policy. Doing so would cost roughly $44 billion. To top of page

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