The Geology of the Fiscal Cliff

The Geology of the Fiscal Cliff
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The Geology of the Fiscal Cliff

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.