The election is over and no matter how it turned out from your perspective the next two months may be more important than the outcome of the election. January 1, 2013 marks the day that automatic spending cuts hit health care and defense and automatic tax increases affect everyone – it’s called “sequestration”. The cuts and tax increases were mandated when the U.S. raised its debt ceiling earlier in the year. A bipartisan group was charged with coming up with a plan for the government to decrease spending and increase revenue but when they were unable to agree on a plan the automated cuts and tax increases were made into law.
It’s widely thought that if the automated cuts and tax increases go into effect it will cause the U.S. to slip back into a recession. The President and Congress have about 45 days to hammer out a plan to avoid the cuts. There are 5 possible outcomes for the fiscal cliff scenario.
- Go over the cliff. We have a lame duck congress and do we really want someone who will not be accountable to a plan making such an important decision and will they be motivated to get anything done? Who knows. As a part of the solution, congress must develop comprehensive tax reform. I don’t see that happening in short order.
- A deal could be brokered. If, and I mean IF, congress and the President can agree on a framework for tax reform and entitlement reform the agreement could buy time and allow discussions and a final plan to stretch into the first part of 2013. Agreement hasn’t been easy to come by in Washington the past four years and I doubt we will have much agreement on a game changing plan by the end of this year.
- Take taxes out of the picture. One of the major sticking points for both parties are taxes. Republicans believe that taxing the wealthy will slow the economy and some Republicans have taken a hard-line against any new taxes. Democrats want to tax the wealthy more but decrease taxes for the middle class. If the two parties could give a little to one another on taxes they may be able to focus efforts on fixing unemployment benefits and automatic rate decreases for Medicare providers. I see this as the most likely scenario. Some of the current tax cuts will be extended to appease both parties and energy will be focused on issues that do not revolve around taxes. As I said, I see this as the most likely scenario but I’m not sure it will be enough to offset what was to occur with sequestration.
- Kick the can. If a permanent fix can’t be achieved Washington is notorious for kicking the can and delaying a solution. I don’t see this as a viable alternative. The stock market has dropped like a rock since the election because of uncertainty around the fiscal cliff and delaying a solution may cause further turmoil in the market. The U.S.’s credit rating is likely to be downgraded as well which could hurt foreign investment in the U.S. and no one wants to limit investment at this point.
- Do a little now and a little then. Congress could do just enough to give the markets faith and buy itself more time. This will be tough because, honestly, who will have faith that anything done before the end of the year is anything other than symbolic.
The right solution is reduction in spending and increased taxes but who wants to do that? No one wants to but no one wants to be Greece either.