There has been quite a lot of talk lately in both political cirlces and in the personal finance community about the “fiscal cliff.” Yet, many still wonder what the fiscal cliff is all about. Never fear! Just like Clarissa of Nickelodeon shows past, Club Thrifty is here to explain it all to you!

 

(Start playing this song and continue reading!)

 

What is the Fiscal Cliff?

What Is the Fiscal Cliff and Why Should You Care?

 

The fiscal cliff is not to be confused with the growing national debt here in the United States. They are two separate things. In fact, the fiscal cliff is a prediction about the expected budget deficit reductions in beginning on January 01, 2013. It also predicts the effect that those will reductions will have on the national economy. Reducing the deficit doens’t sound so scary right? We need to get our spending under control, so why give it such a frightening name?

Do you remember when we had those contentious debates about whether or not to raise the “debt ceiling” back in the summer of 2011? Maybe you remember hearing about a “Super Committee?” Essentially, congress failed to reach a real agreement about which programs and taxes should be cut in order to raise the debt ceiling. Instead, they passed the Budget Control Act of 2011 and raised the debt ceiling anyway, passing the buck onto the Super Committee. The Super Committee was given about 2 months and charged with eliminating $1.2 trillion from the federal budget over the next 10 years. While the creation of this super committee was highly unusual and probably illegal, the idea was to avoid partisan debate and gridlock so that the government could continue to function and not default on it’s loans. Of course, the Super Committee failed.

 

Where Does That Leave Us?

In the event that the Super Committee failed to come to an agreement, congress provided a provision in the Budget Control Act of 2011 that required program cuts and tax hikes across the board. Of course, nobody wanted to actually have to be held accountable for these provisions. Thus, these tax hikes and program cuts are set to begin on January 01, 2013 – about 2 months from now.

 

What’s the Big Deal and Why Does It Matter to Me?

So, what sort of changes are we actually talking about here? Will you even notice a difference in your daily life? The fact is, you might.

In brief, much of the spending and several of the tax cuts that have been passed over the last decade will now expire. The Bush-era tax cuts will expire, and be returned to pre-Bush levels. The 2% Social Security payroll tax cut will also expire. So, yes, you are going to see a difference in your take home paycheck.

In addition, most discretionary spending will be cut across-the-board. The costs of Medicare are also expected to rise as the measures put in place to delay increasing reimbursement rates are also set to expire.

 

Have I Scared You Yet?

For personal finance wonks, this should seem like a good thing, right? After all, we are always telling you that you need to stick to a budget right? The fact is that you can’t spend more than you make and expect not to be broke, right?

On a personal level, this is absolutely true. I would advise you to make all of your spending changes immediately. However, when it comes to large scale cutting and spending like this, doing everything all at once can be a very dangerous thing to an economy as a whole. While the Congressional Budget Office expects federal revenues to increase nearly 3% and spending to decrease by .5%, the CBO also warns that we may face rising unemployment and a second recession in 2013. Nevermind Freddy and Jason! A second recession could be some serious scary! Of course, declaring national bankruptcy could be even worse.

 

So, what do we do? If we “avoid” the fiscal cliff, economic conditions will be similar to 2012 but our national debt will continue to explode. If we fall off the cliff, our deficit is predicted to decrease but economic conditions could worsen. It is quite the conundrum, isn’t it?

The fact is that between now and January 1, the lame duck congress and a possible lame duck president aren’t going to be able to do much. Some experts warn us that falling off the fiscal cliff could be disastrous to the economy. Others believe that if such difficult conditions arise, it may force legislators to make a better deal. What do you think? Let us know in the comments below!

…Oh, and have a Happy Halloween! Muhahahahahahaha!