Fiscal Cliff

What Is A Fiscal Cliff?

A fiscal cliff is any series of potential economic events and factors that could combine to cause a severe and sudden economic downturn. The term most offers refers to the situation in the United States in 2012 and 2013 when a combination of budget deadlines, looming debt ceiling issues, and expiring tax cuts threatened to damage the U.S. economy.

How The U.S. Came Close To The Fiscal Cliff

While the crisis came to a head in 2012, it has its roots back in 2001. President George W. Bush signed a series of sweeping tax cuts into law in 2001 and 2003.^[1] Those tax cuts were passed with an expiration date. While they were extended a few years, they were set to expire Dec. 31, 2012 and Congress seemed unlikely to renew them.

In addition to the Bush era tax cuts, there were other tax cuts that were set to expire at the end of 2012 and the beginning of 2013, including a payroll tax cut championed by President Obama.^[2]

The expiring tax cuts, however, were only a part of the problem. Because Congress had not passed a full budget bill in 2011, an earlier law (the so-called "sequester") was also scheduled to take effect at the end of 2012. The sequester was designed to bring about steep and sudden spending cuts across almost all federal programs. The sequester itself was the result of tense negotiations over raising the debt ceiling and the federal budget between President Obama and congressional Republicans in the summer and fall of 2011.^[1]

Even though Republicans held a majority in the House of Representatives and the Senate, because of Senate rules, the Republicans were not able to pass legislation in the Senate without Democratic support. If the legislative standstill was not resolved, it was feared the combination of the sequester and the expiring tax cuts would send the country back into recession.

How The Crisis Was Avoided

A short-term compromise was eventually worked out, before any of the tax cuts expired or the budget cuts took effect. The compromise made many of the Bush era tax cuts permanent. It also raised the tax rates on individuals making more than $400,000 a year and couples making $450,000. The compromise delayed the implementation of the sequester cuts by two months, giving Congress more time to work out a budget.^[4]

Will There be Another Fiscal Cliff?

While the exact combination of events is unlikely to repeat itself, the U.S. may be at risk for another showdown with a fiscal cliff. The underlying political balance of power has not changed much since the 2012 crisis.

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