Fiscal Cliff 'Cliffs Notes': How We Got to the Edge in 5 Easy Steps

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Fiscal Cliff

It seems like only yesterday that the fiscal cliff was a distant worry, a muffled rumble of thunder over the horizon. Yet as other stories have occupied the headlines, the cliff has drawn ever nearer. It has now been almost a year and a half since President Obama and Congress forged a pact to set the country on an autopilot course into economic Armageddon unless they were able to reach an agreement on the federal budget. Of course, that agreement never arrived, last-minute negotiations appear to be stalled and we are now staring down the barrel of a 12-gauge economic crisis.

With Jan. 1, 2013, less than three weeks away, we're looking back at the path we took to reach the crisis point with this quick refresher course.

Fiscal Cliff 'Cliffs Notes': How We Got to the Edge in 5 Easy Steps

The genesis of fiscal cliff dates back to 2001 and 2003, when Congress passed the Bush tax cuts, which -- among other things -- reduced income tax rates by between 3% and 5%, slashed the estate tax rate, massively cut the dividend and capital gains tax rates, and expanded tax credits. Many of these cuts were set to expire in 2011, but  all 42 Republican senators threatened to block any legislation that year unless the cuts were extended. President Obama ultimately agreed to do so.

As part of Obama's 2010 deal to extend the Bush tax cuts, Congress agreed to pass a payroll tax holiday. A one-year, 2 percentage point cut in the payroll tax, the result was an instant infusion of cash directly into the paychecks of every U.S. worker.

Congress and Obama agreed to extend the tax holiday for 2012, but it's set to expire on Jan. 1, 2013 -- meaning that every U.S. worker making less than $110,000 will get hit with the equivalent of a 2 percent pay cut.

The Bush tax cuts left a big hole in the government's revenues, a problem that worsened during the recession, when the government borrowed money to bail out Wall Street and shore up the social safety net. In 2011, faced with an exploding deficit, Congress refused to raise the country's debt limit unless the president agreed to slash the budget.

Ultimately, the two sides compromised: Congress raised the debt ceiling and the president agreed $2.2 trillion in cuts. The first $917 billion began to be phased in immediately, and the remainder were punted to a special congressional committee.

The Joint Select Committee on Deficit Reduction, also known as the Supercommittee, was a bipartisan group of 12 senators and congressmen tasked with devising a plan to cut the deficit by $1.2 trillion. Formed in August 2011, the group was given a tight deadline -- and a chilling threat: If it failed to come up with a bill by late November -- or if Congress failed to pass the bill it sent them -- "sequestration" would kick in: $1.2 trillion in automatic, across-the-board cuts to all discretionary government programs. On Nov. 21, 2011, the Supercommittee closed up shop, admitting that it had been unable to reach an agreement.

If sequestration happens, it will cut 2 percent from Medicare reimbursements to doctors, and pull a crippling 7.6 percent to 9.6 percent out of all discretionary programs, including the defense budget.

While there's disagreement about just how painful the impact from a leap off the fiscal cliff would be, most experts agree that the rapid cuts in government spending would push the nation toward another recession, while the increases in taxes on middle-class and poor Americans would likewise put the brakes on economic growth. The result would mirror Europe's ongoing austerity crisis, in which the combination of broad tax hikes and deep spending cuts sent many countries into recessionary death spirals.

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Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.
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