If you haven't already heard the phrase "fiscal cliff," get used to it. You'll be hearing a lot about it over the next six months.
One of the most important but unknown facts about the federal government's massive budget deficit is how easy it is to fix. If Congress and the president do nothing and let all current laws play out as they're written on the books, the United States does not have a budget problem. At all.
The problem is that it requires a few things to happen:
- All of the Bush tax cuts need to expire on Jan. 1, 2013, as they're currently set to.
- A huge scheduled cut in Medicare payments to doctors needs to occur. This has been on the books since 1997, but is temporarily patched up through the so-called "doc fix."
- Spending cuts mandated by last year's debt-ceiling deal have to actually happen.
The bigger problem is that no one -- not conservative politicians or liberal politicians or conservative economists or liberal economists -- wants to see all of that happen, especially at once. One group says the tax hikes will whack the economy while it's still weak and unemployment will rise. The other says spending cuts will whack the economy while it's still weak and un employment will rise. Both are probably right.
If Washington can't agree on what to do and all three policies play out as they're currently on the books, we hit the fiscal cliff on Jan. 1, 2013. If the policies are extended, we get a fairly smooth path:
Source: Congressional Budget Office.
Here's what Federal Reserve chairman Ben Bernanke had to say about the fiscal cliff during a press conference last month:
I think it's very important to say that if no action were to be taken by the fiscal authorities, the size of the fiscal cliff is such that there's, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy. So as I have said many times before, it's imperative for Congress to give us a fiscal policy that achieves two principal objectives. The first is, of course, to achieve fiscal sustainability over the longer term; that is critical, and that's something that needs to be addressed. At the same time, I think that can be done in a way that doesn't endanger the short-term recovery of the economy. And I am concerned that if all the tax increases and spending cuts that are associated with the current law and which would take place -- absent any congressional action -- were to occur on January 1st, that that would be a significant risk to the recovery. So I'm looking and hoping that Congress will take actions that will address both sides of that-- both requirements of a good fiscal policy.
Will Washington be able to strike a deal, some compromise between the cliff and the extended deficits? Hard to say -- especially in an election year.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.