A Drive Over America’s Fiscal Cliff

As the U.S. stock market pushes to a 3 month high amid strong corporate earnings and a positive July jobs report, some investors who remember the tumultuous days of summer last year in 2011 during the debt ceiling showdown with Congress are now beginning to wonder if America heading down an even bigger fiscal cliff at the end of 2012.

Fortunately, there is no looming debt ceiling end date around the corner in the United States, unlike the 2011 countdown to Aug. 2nd — the date when the U.S. Treasury Department admitted it would no longer be able to pay all its bills unless Congress resolved the impasse over raising the $14.3 trillion debt limit.

However, there is another fiscal battle heating up in Washington D.C. today that could take a dramatic turn at the end of 2012 with the potential to cause more market volatility and economic uncertainty.

In January 2013, $1.2 trillion in automatic spending cuts- the so-called sequestration- are set to begin and a set of tax cuts over $200 billion enacted under President Bush are scheduled to expire, raising tax rates for millions of Americans.

Benefits for education, retirement, children’s nutrition, and low-income Americans will end.

Payroll taxes will increase, immediately lowering the salaries for millions of Americans and the spending habits in the broader economy. 

The payroll tax break is set to expire in December whereas the Bush tax cut is set to expire on Jan. 1st, unless politicians in Washington D.C. can decide to extend the cuts. 

Since payroll taxes are deducted from salaries on a weekly basis, their impact will be more immediate compared to the income tax rate increases which affects income starting in 2013.

The payroll tax cut is worth 2% of one’s wages up to $110,100 for 160 million working Americans.

It was intended as a temporary measure for 2011 but was extended for 2012.

Sequestered Cuts

The sequestered cuts will impact $54.7 billion in defense and $54.7 billion  in non-defense programs per year through 2021.

According to Richard Kogan’s article from the Center on Budget and Policy Priorities, the sequestered law calls for $1.2 trillion in deficit reduction through 2021; it requires $984 billion in budget cuts and assumes those savings will reduce interest payments by $216 billion.

“The $984 billion in budget cuts is spread in equal dollar amounts over each of the nine years 2013-2021, or $109.3 billion  per year.  Those cuts themselves are  divided equally between the ‘national defense’ budget function and all other budget functions: $54.7 billion per year in defense and $54.7 billion per year  in non-defense programs” Kogan states.

“A  defense sequestration of $54.7 billion would entail a cut of about 7.5 percent  in defense programs, including war funding and unobligated balances, if  military personnel funding is not exempt from sequestration” Kogan writes.

The $54.7 billion in non-defense  cuts will come from both mandatory (entitlement) and discretionary (non-entitlement)  programs.

Political Wrangling

Republicans used their radio address on Saturday to pressure President Obama into supporting a full extension of the Bush tax cuts.

This comes after the Republican controlled House (Congress) passed a bill last Wednesday to extend the Bush tax cuts.

President Obama has promised to veto the bill.

President Obama said on his campaign trail that he is open to the possibility of extending the Bush tax cuts for middle and low income Americans but he is reluctant to extend the Bush tax cuts for the wealthiest Americans.

President Obama explained that he wants to allow the Bush tax cuts to expire on income after the first $200,000 earned by individuals and the first $250,000 made by couples.

Congress is expected to address the Bush tax cut impasse following the November elections.







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