By Jim Wisdom on June 22, 2012
In the 2000 movie “The Perfect Storm”, George Clooney takes a great risk in facing two storms and a hurricane in order to make it to shore before his crew’s catch goes bad. This movie serves as a good analogy of the harrowing risks our legislators are taking in Washington right now with “the fiscal cliff” ( also known as “taxmageddon”).
What is the fiscal cliff? It’s a toxic combination of tax increases and spending cuts that will happen on Jan. 1, 2013 if Congress doesn’t act sooner. Below is a summary of the key provisions set to take effect in 2013:
• The Bush Tax Cuts would expire. These same tax cuts were set to expire on at the end of 2010; however, Congress extended them until Dec. 31, 2012 because of the fragile economy.
• An estimated $1.2 trillion cut in federal government programs. This provision was agreed to by last year’s “Supercommittee” following the debt-limit showdown last summer and includes cuts to the military, Medicare pay for doctors, the end of various tax breaks and more restricted unemployment benefits.
• Expiration of a temporary payroll tax that was passed by Congress in 2011.
What will be the impact if the fiscal cliff takes place? As noted in Barron’s recently, the The Liscio Report projects a fiscal squeeze of 4 percent overnight, which is likely to lead to a recession. Or, as the Liscio report put it, “the fiscal cliff we are headed for in seven months would be on a par with some of the world champions in the austerity Olympics.”
Without the fiscal cliff concerns, GDP was projected to grow by 4.4 percent next year. However, the added uncertainty of the fiscal cliff means that the economy is projected to grow by 1 percent to 2 percent on an annualized basis. This event would be a tremendous hit to an already fragile economy.
To complicate matters even more, all of these decisions are scheduled to be decided during a lame duck, very divisive Congress. Further, this lame duck session will take place immediately after an election that, by most accounts, will be very divisive.
Consider the possibilities. In one scenario, a new President-elect Romney is nominated in a very close, divisive election, while the Republicans pick up more seats in both the House and Senate. Will the Democrats (particularly those that lose their seats in 2013) have any reason to cooperate with the Republicans and President-elect Romney?
Or, maybe President Obama survives a close re-election battle, but the Democrats lose some House and Senate seats. Will the Republicans have any incentive to work with Democrats during the lame duck session?
The impact of all this uncertainty is already being felt by businesses across the country. Many employers who were planning to expand operations in 2012 are postponing these plans until there is more certainty in the economy.
Even Federal Reserve Chairman Ben Bernanke recently warned Congress to not let the fiscal cliff destroy the economy. He spoke about the “sudden and severe contraction in fiscal policy” that poses a serious risk to a fragile economic recovery. And, if Congress and the White House choose to kick the can down the road and postpone these tough decisions into the first or second quarter of 2013 (another option being considered), it’s possible that the U.S. will be subject to another credit-rating downgrade such as the one delivered by Standard & Poors last year.
In summary, the White and House and Congress are playing with fire here. Let’s hope that the politicians in Washington will act like grown-ups this year and reach an agreement before the election. Given last year’s debt limit showdown, this sense of hope may prove to be unrealistic.
• Jim Wisdom is president of James L. Wisdom Insurance Services, an insurance and financial services firm based in Westlake Village.