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Your Complete Guide To The Coming Fiscal Cliff

Tyler Durden's picture




 

All you need to know about the fiscal cliff which will savage the US economy in under 5 months, unless Congress finds a way to compromise at a time when animosity and polarization in congress is the worst it has ever been in history.

 

Key dates:

 

The cliff in graphics:

 

The cliff in numbers:

 

The players:

And a Q&A from Goldman with its DC political economist Alec Phillips:

What is the “fiscal cliff”?

Alec: It’s the unhappy coincidence of about $600bn in tax increases and spending cuts that come about on January 1, 2013. Last year, we started calling this the “fiscal cliff.” On the tax side, the most significant policies are the income tax cuts enacted in 2001 and 2003, and the payroll tax cut that has been in place for the last two years. The spending cut comes mainly from the “sequester,” with a smaller effect from the expiration of expanded unemployment benefits.

What do you mean by the “sequester”?

Alec: When Congress raised the debt limit last year, the bill it passed included over $2 trillion over ten years in projected spending cuts, from capping annual spending bills and a flat $109bn per year cut in spending known as the “sequester” that would take effect if a deficit reduction “super committee” failed to agree on $1.2trn in savings. The super committee failed, so now the sequester is scheduled to cut spending at the start of 2013, applied equally to defense and domestic spending.

How does the debt limit fit in?

Alec: It’s indirectly related to the fiscal cliff, since Congress will need to address it either at the end of this year or early next year. The debt limit is a legal cap on the amount of debt the Treasury can issue—it currently stands at $16.4 trillion—and covers publicly held debt as well as debt in the Medicare and Social Security trust funds. We think the limit will become binding on the Treasury by February 2013, though hopefully Congress will raise it when they deal with the fiscal cliff at year end.

What happens if the debt limit isn’t raised?

Alec: The Treasury brings in about $200bn each month, but pays out about $300bn, so it would be able to pay most but not all  of its bills, with missed payments going into arrears. For some areas a sort of “first in first out” system might make sense, but it  seems likely that the Treasury would prioritize interest payments.

What would be vulnerable to cuts in this situation?

Alec: Payments to federal employees, contractors, and health providers under Medicare would probably see effects right away. States, which receive hundreds of billions per year in federal grants, could also see a reduction in revenues. Social Security and other types of payments would probably also be delayed.

What are the key dates ahead for these issues?

Alec: The House recently voted to extend the 2001/2003 tax cuts in their entirety, and the Senate voted to extend the tax cuts on income under $250,000. Spending authority will need to be extended for the coming fiscal year before the current one ends on Sep. 30, but that looks fairly likely to happen without too much controversy. The election on November 6 will be the next key  date, after which Congress is expected to come back and deal with the fiscal cliff, but any resolution most likely won’t occur until the end of December. If there is no resolution by then, Congress may come back early in 2013 and address it retroactively. We expect to hit the debt limit in February, which is around the same time that the semiannual interest payment on Treasury debt is due (see Page 3).

Will the election influence how this gets resolved?

Alec: Yes. Overall, the Republican position is to extend all of the income tax cuts and to avoid the defense cuts. Most Democrats prefer avoiding defense and non-defense cuts, and would like tax revenues to replace some of the lost savings from doing so.  They also oppose extending the income tax cuts on upper incomes.

Will the election influence when this gets resolved?

Alec: Probably, but it’s not clear in which way. A clear-cut election victory by either party could hasten an agreement, while a close election could lead to a more protracted debate. On the other hand, if one party—the Republicans, for example—were to gain control of Congress and the White House, they might opt to delay action until they gain control 2013 if they can’t win concessions in 2012. A status-quo election outcome—i.e., the President wins reelection and the Democrats hold the Senate—might make an agreement in the lame duck session of Congress more likely. Of course, there is no clear-cut answer in any of these scenarios.

Will the fiscal cliff happen?

Alec: It’s not our central expectation. We assume that Congress will act in the lame-duck session after the election to  extend most of the current policies until sometime in 2013. A three-to-six-months extension would allow them to address the debt limit and provide some time to come up with a longer-term fiscal plan that may involve tax reform and/or entitlement (Social Security/ Medicare) reform. The only part of the fiscal cliff that we expect to take effect at year end is the expiration of the payroll tax cut (because there seems to be broad agreement that this will eventually need to expire), along with continued phase down of emergency unemployment benefits.

What are other scenarios and their probabilities?

Alec: You have two general scenarios, one is that they extend the policies past the end of the year and the other is that they  don’t. We think the odds that the fiscal cliff is allowed to take effect at the end of the year are probably about one in three. If that happened, Congress would probably step back in 2013 and reverse some of it, though even a temporary lapse could be disruptive for markets and the real economy. A long-term agreement before year end (i.e., longer than a full year) seems to be the least likely outcome.

Will the debate be cleaner or messier than last year?

Alec: Messier. First, the issue is just bigger. Last year, we just had the debt limit, whereas this year we have that same threat plus the fiscal cliff. Also, in order to resolve the issue last year Congress was able to agree to lower overall spending levels withoutspecifying where those cuts would come from. Now that those “easy” savings have been used, the options left are more specific spending cuts or tax increases that are more politically painful. Also, some politicians may find it advantageous to let the tax cuts expire, which would enable them to come back next year and enact tax relief on a smaller scale than exists currently. Even though it would lead to an overall increase in revenues, this would allow them to cast a vote to cut taxes next year (once rates have increased) rather than a vote to raise them this year.

What is the economic impact of your base case?

Alec: We assume a drag on GDP growth from fiscal policy of about 1.5% in 2013, due to the expiration of the payroll tax cut along with some smaller factors. Even if Congress extended everything, we think that federal fiscal policy would still weigh slightly on growth, particularly since federal spending is slowing.

What would the impact be of falling off the cliff?

Alec: If Congress took no action, we estimate around a 4% hit to GDP growth in 2013. If you assume an underlying trend of around 2.5%, that is likely to put the economy into recession. There might be some mitigating factors: Consumers might initially tap savings or borrow and not all of the federal spending cuts would kick in on day one. It is also possible that some business investment or hiring has already been delayed and could restart once the uncertainty has passed. But overall, letting these policies lapse all at once would be a very negative outcome. Of course, a short lapse that the new Congress quickly addresses in January would do less damage to the economy, though damage to policy credibility and markets might still be significant.

What is the Fed’s role here, if any?

Alec: In our base case we already assume that the Fed is going to ease policy in September, with renewed balance sheet  expansion late this year or early in 2013. If we fall off the cliff in a more significant way, then the likelihood of easing and the  magnitude of this easing would go up. But the Fed can’t offset a fiscal contraction of the size we’re talking about.

What sectors would be most impacted?

Alec: Defense and healthcare are the most obvious sectors, because they have relatively large shares of revenue from the Federal government, and they are also two places that the sequester is scheduled to hit hard at the end of the year if Congress doesn’t act. The cut to defense spending in particular would be almost certainly greater than 10% and may be closer to 20%. The fiscal cliff would also hit consumers’ disposable income, which is an important distinction with last year’s debt debate, in which most of the policy discussions were confined to a narrow set of industries and had little direct impact on consumers.

How concerned is the market about these issues?

Alec: To assess this, you can look at a basket of stocks that our colleagues in equity research have put together, which tracks
companies with large shares of government-related revenue. This index dropped very significantly on a relative basis to the S&Pabout a month ahead of the debt limit last year and it never fully recovered. We are starting to see some of that again this year, but the magnitude is obviously not the same so far. The other area where you would expect to see it is in consumer  onfidence and we have seen some weaker confidence numbers recently, though, again, nothing like we saw around the debt limit last year.

Allison: Will the market react sooner this time?

Alec: Potentially, but it’s unclear. Last year we saw a clear reaction to the debt limit debate only about a month before the deadline. One would imagine the reaction this year would come further in advance of the event, since it’s a bigger issue and also because there are plenty of people who were caught off guard by last year’s developments and might be more proactive this time. That said, my sense is that many in the market are withholding judgment until the election happens, because it’s just so hard to predict before then how all of this will be resolved. That could mean a sharper reaction post-election, depending on the situation.

Will the US be downgraded again this year?

Alec: Probably not. It wouldn’t make much sense for the rating agencies to take a strong view on fiscal sustainability just ahead of the election and resolution of the fiscal cliff. They have implied as much in their recent commentary. That said, I believe the risk of a downgrade reemerges again next year, depending on how these fiscal issues are resolved. If a longer-term fiscal agreement either doesn’t happen next year and Congress continues with a sort of muddle-through approach, or if the agreement is just not as substantial as some would expect it to be—i.e., they aren’t able to stabilize the projected debt/GDP ratio by later in the decade—then a downgrade seems possible.

Will this series of events ultimately serve as a positive catalyst for longer-term fiscal reform?

Alec: Hopefully. The good news is that both parties seem optimistic that tax reform will be enacted next year. If it happens, it could also allow for entitlement reform. The bad news is that they need to bridge fundamental disagreements to get there. They are also working from a smaller segment of the budget—neither party appears comfortable with significant cuts to Social Security or Medicare in the next decade, and they disagree on how to handle taxes and some other areas of the budget. That doesn’t  leave a lot of areas of the budget to work with to achieve savings.

Source: GS

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Thu, 08/09/2012 - 14:32 | 2691789 ReallySparky
ReallySparky's picture

Alec, I'll take Gold for 1650.

Thu, 08/09/2012 - 14:45 | 2691823 Beam Me Up Scotty
Beam Me Up Scotty's picture

Don't forget the silver at $28 too.

Thu, 08/09/2012 - 14:48 | 2691834 Pladizow
Pladizow's picture

Where's the Willey Coyote?

Thu, 08/09/2012 - 14:59 | 2691859 Comay Mierda
Comay Mierda's picture

he's getting ready to drop bombs on Iran to distract the sheeple

Thu, 08/09/2012 - 15:05 | 2691872 economics9698
economics9698's picture

Obama would suck a Jew cock to get re-elected. 

Thu, 08/09/2012 - 15:16 | 2691904 sickofthepunx
sickofthepunx's picture

if that's the case, i ahudder to think what romney would do.....

Thu, 08/09/2012 - 15:19 | 2691911 economics9698
economics9698's picture

Snort a line of coke?

Thu, 08/09/2012 - 15:45 | 2692008 fuu
fuu's picture

"Source: GS"

Which part am I supposed to fade?!?

Thu, 08/09/2012 - 17:53 | 2692309 slewie the pi-rat
slewie the pi-rat's picture

this ain't gonna help...

...but :>  Report Reveals IRS Failing to Detect or Prevent Fraudulent Tax Returns Aug 9th, 2012, 12:29 - FGI (Length: 2300)  <:

lindaGreen has a brand new bag?  my inner sherlock is thinking "hi-speed integrated accounting fraud tied to vaporwear?" 

let's do the IPO, BiCheZ!

Thu, 08/09/2012 - 19:39 | 2692546 AldousHuxley
AldousHuxley's picture

no statue of limitations on robbing uncle sam.

Thu, 08/09/2012 - 20:07 | 2692626 lemonobrien
lemonobrien's picture

with a millions dollars its fairly easy to leave and never come back.

Fri, 08/10/2012 - 11:09 | 2694015 short-swap
short-swap's picture

"In our base case we already assume that the Fed is going to ease policy in September, with renewed balance sheet  expansion late this year or early in 2013."

 

Priced Fixed in.

Thu, 08/09/2012 - 23:28 | 2693033 StychoKiller
StychoKiller's picture

"There once was a crooked man, and he did very well!" -- Inner-City Mother Goose

Thu, 08/09/2012 - 15:38 | 2691977 LFMayor
LFMayor's picture

Oh, something wild and over the top.  Like flog his dog to the women's bra and undwear section of JC Penny's catalogue.  That guy seems so straight laced and his ass squinched so tight i bet he shits copper wire when he accidentally swallows pennies.

freak out!

Thu, 08/09/2012 - 15:50 | 2692030 azzhatter
azzhatter's picture

Next we'll see a report he discovered his long lost Uncle Moshe is from Tel Aviv

Thu, 08/09/2012 - 15:19 | 2691909 ParkAveFlasher
ParkAveFlasher's picture

ACME BUNKER BUSTER - DO NOT DROP!!!

Thu, 08/09/2012 - 14:52 | 2691844 hannah
hannah's picture

hope you filled out that 1099k form so the governmant can track your gold......

Thu, 08/09/2012 - 17:28 | 2692264 JohnKozac
JohnKozac's picture

At first I thought it said, "Fiscal Cliff Members"....not "fiscal cliff numbers."

 

Thu, 08/09/2012 - 17:51 | 2692303 Arnold Ziffel
Arnold Ziffel's picture

Congress Repeals the Obamacare 1099 Requirement

Posted by James Wilson, April 21, 2011 http://www.downsizedc.org/blog/victory-congress-repeals-the-obamacare-10...
Thu, 08/09/2012 - 14:34 | 2691798 mrktwtch2
mrktwtch2's picture

yes..god forbid we should live within our means..lol we will just let the next generation pay for it..

Thu, 08/09/2012 - 14:43 | 2691819 A Lunatic
A Lunatic's picture

Charge it to my SNAP card.........

Thu, 08/09/2012 - 15:13 | 2691894 economics9698
economics9698's picture

When the feds borrow money and the new money is created you do pay for it as soon as the new money hits the street in the form of inflation. 

Thu, 08/09/2012 - 16:53 | 2692192 A Lunatic
A Lunatic's picture

There is no inflation. Only drought.......

 

 

/s

Thu, 08/09/2012 - 17:07 | 2692230 pemdas
pemdas's picture

Speaking of SNAP cards, a woman at checkout was having trouble getting her card to work.  She says, "These things are such a nuisance, I have three of them, and I can never remember which PIN goes with which card."  Probably not a fan of voter ID either.

Thu, 08/09/2012 - 14:46 | 2691827 Beam Me Up Scotty
Beam Me Up Scotty's picture

Why stop at the next generation.  We can suck from every generation until the sun goes nova.  Then who cares?

Thu, 08/09/2012 - 16:46 | 2692177 OneTinSoldier66
OneTinSoldier66's picture

"What has the next generation ever done for us?" -Hugh Jidette

Thu, 08/09/2012 - 14:54 | 2691849 FreedomGuy
FreedomGuy's picture

You mean the next- next generation, right? I think we've caged three or four generations with debt already. So what's a fifth generation matter?

Thu, 08/09/2012 - 16:58 | 2692210 HardAssets
HardAssets's picture

Some day in the distant future historians will shake their heads in amazement at our criminal run 'civilization' built on the illusions of 'credit' and 'debt'. (All made up out of thin air). - - - Theyll wonder why people went along with it. - - - Makes as much sense as enslaving people to build pyramids so the Pharoh can go on to the afterlife. 

 

Thu, 08/09/2012 - 18:56 | 2692444 centerline
centerline's picture

Some day, alien archeologists will...

... not surpised at all of thier findings that humans did not survive thier adolescence as a species, but impressed at how far we made it in terms of technological advances before we exhausted the possibilites for our survival."

 

"On a long enough timeline..."

 

Thu, 08/09/2012 - 19:00 | 2692452 Axenolith
Axenolith's picture

No, they won't.  They'll do the exact same thing, denominated in something like quatloos or chits, and there will be an eclectic tiny minority of intelligent people tilting at their ponzi windmill (like us) and wondering how they can do this YET AGAIN after having seen it happen time and time again in the past...

ALl the time they're doing it again, the sheeple will be assured via their cybernetic links to the metaverse that "it's different this time"...

Thu, 08/09/2012 - 21:40 | 2692833 ZeroAvatar
ZeroAvatar's picture

Axenolith, if you're not Charles Hugh Smith, I'll be a stockade mule.

Thu, 08/09/2012 - 15:58 | 2692057 blunderdog
blunderdog's picture

The only part that really requires attention was at the very end:

neither party appears comfortable with significant cuts to Social Security or Medicare in the next decade

Thu, 08/09/2012 - 16:45 | 2692189 OneTinSoldier66
OneTinSoldier66's picture

Oh SNAP!

Thu, 08/09/2012 - 16:47 | 2692191 DaveyJones
DaveyJones's picture

translated into english: neither party is anything more than an incompetent, paralyzed, two-talking whore

Thu, 08/09/2012 - 17:42 | 2692290 object_orient
object_orient's picture

Or this: We assume that Congress will act in the lame-duck session after the election to extend most of the current policies until sometime in 2013. A three-to-six-months extension would allow them to address the debt limit and provide some time to come up with a longer-term fiscal plan...

 

Kick the can for another 6 months

Thu, 08/09/2012 - 14:37 | 2691799 Clint Liquor
Clint Liquor's picture

This a non-issue. They will come together to pretend and extend at the very last minute, like always.

The 'Players'! A list of people that can kiss my ass.

Thu, 08/09/2012 - 14:46 | 2691830 Winston Churchill
Winston Churchill's picture

Pretend and pray the bond traders do not notice.

Its too late anyway unless drastic real cuts are made at once.

Not going to happen.

The SHTF moment  is coming,as late as 2014 or any time in between.

Keep preparing.

Thu, 08/09/2012 - 15:08 | 2691879 Gunga
Gunga's picture

Bond traders have noticed. That is why the Federal Reserve buys 60+% of the US Treasury bonds that are auctioned.

Thu, 08/09/2012 - 16:14 | 2692099 Winston Churchill
Winston Churchill's picture

Let me rephrase that;

Short end bond traders.

NOBODY is buying long dated UST's except the Fed.

They are junk and will never be repaid.

Thu, 08/09/2012 - 15:25 | 2691925 NotApplicable
NotApplicable's picture

Exactly. They just have to wait for enough pain to create a "mandate."

This shit ain't rocket science.

Thu, 08/09/2012 - 16:52 | 2692204 DaveyJones
DaveyJones's picture

kissing your ass is way too kind sir

Thu, 08/09/2012 - 18:58 | 2692447 moonshadow
moonshadow's picture

no way they cud kiss MY ass! their mouths are too dirty...all that kissin up to anything w' votes or money that moves and in every way possible. i dont want them Near my ass. plus im not into pols

Thu, 08/09/2012 - 23:34 | 2693057 StychoKiller
StychoKiller's picture

Com'on, you wouldn't hit this?

Thu, 08/09/2012 - 14:37 | 2691801 Hype Alert
Hype Alert's picture

That's ridiculous!  The Super Committee fixed that last year!

Thu, 08/09/2012 - 15:09 | 2691869 CrashisOptimistic
CrashisOptimistic's picture

I believe this guy has some errors in what he laid out.

First and foremost, the Sequester is not 2 Trillion, it is a bit over 1 Trillion. The other Trillion he refers to IS ALREADY CAST INTO LAW AND OUTYEAR SPENDING PROJECTIONS.

The 1 Trillion Sequester divides between Defense and non Defense, but the other Trillion was already embedded in the spending profiles for upcoming years.  These were DEFINITELY not lumped as the same thing.  The Sequester was argued as a partial tax revenue possibility, but the other Trillion has no such thing -- it is to be purely spending cut.  

That non Sequester trillion is backloaded so that FY 2012 only saw $4B of cuts, but they do sharply kick in starting next year and I think this guy has that wrong.  His number for magnitude of cut next year is only the Sequester portion, not the other Trillion.

This means GS's projection of GDP impact is understated.  Perhaps most important of all is the response by the credit rating agencies, who held off following S&P's lead last year and left AAA in place because this debt ceiling deal did indeed take 2 Trillion off planned spending.

If ANYTHING is done to lessen that, AAA will be lost across the board.

Thu, 08/09/2012 - 15:13 | 2691899 Hype Alert
Hype Alert's picture

IMO, the credit rating agencies have dug their own grave, again.  To the point that a downgrade will be ignored or the rating will be eliminated as a requirement.  Just the threat of another QE should have had them rattling their sabres, but there is nothing but silence that I see.

Thu, 08/09/2012 - 15:29 | 2691918 CrashisOptimistic
CrashisOptimistic's picture

A valid point, but the more compelling one is GS's error above is on the order of 0.5% GDP.  The contraction will be well north of 4%.  

And so tax revs dry up and the whole deficit computation goes to hell.

Or if they undo all the contraction, then we have another year of 1.2 to 1.3T deficit and we expect the agencies to say nothing to that?

I think they have to act.  Especially in the wake of what they have done in Europe.

Overall, this agency constraint needs to get more MSM time so it stops being a matter of politics where all they want to write about is Congress can't agree on stopping the cliff.  There's a LOT more involved in Congress not agreeing.  If they DO agree, it may be worse because as you alluded, a lot of pension funds and state holdings will have to divest, given they have proportion requirements of AAA and above for their portfolios.

Not many noticed last year the weekend S&P acted, Geithner spent that weekend drafting documents for all the pension funds and various holders of US Ts, giving them cover for not executing sales per their bylaws, stating that the S&P move was not universal and thus the paper remained AAA.  He can't do that if all the agencies cut.

Thu, 08/09/2012 - 17:59 | 2692326 object_orient
object_orient's picture

 [Geithner] can't do that if all the agencies cut.

Sure he can. It's about time for governments to nationalize the rating agencies anyway. Sovereign debt is too important to be scrutinized by private businesses, etc.

Thu, 08/09/2012 - 15:27 | 2691926 sessinpo
sessinpo's picture

The MSM misinformed everyone again. It was really a supper committee. Apparently they all just sat around eating food.

 

I imagine if they form a committee to tackle the drought conditions that will turn the mid west into a desert, it will really be a bunch of fat bastards eating cake and ice cream.

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