On Jan. 1, the largest tax increase in American history is scheduled to occur. It includes increased income taxes, estate taxes, Obamacare taxes, Medicare taxes and Social Security taxes. In addition, $1.2 trillion of federal government spending cuts are mandated over 10 years. That means $120 billion in spending cuts are scheduled for 2013.
The nonpartisan Congressional Budget Office says that if the United States does not repeal these taxes and spending cuts, the country will fall off the "fiscal cliff." Falling off the fiscal cliff will result in a recession starting next year with unemployment in the 9.1 percent range and as much as a 2.9 percent contraction of economic growth in the first half of the year.
It may not be intuitive to people who are not in business or economics professions why increased taxes and reduced federal spending will send the U.S. into a recession. However, it is not hard to understand the economic logic that causes this result.
If the highest income-tax rate increases from its current 35 percent to 44 percent (including Medicare and Obamacare tax increases) on the wealthiest taxpayers, a family making $500,000 will have $45,000 less to spend. That family may decide to cut out a gardener, a housekeeper, a vacation or even a new yacht. A progressive might say, "So what, they are rich, and they will still have an opulent lifestyle." Unfortunately, that does not help the newly unemployed housekeeper or gardener find a job.
If the high-income family makes money from a small business, such as a restaurant, the owner may decide not to cut personal spending but to reduce investment in the restaurant. Perhaps the restaurant owner decides not to buy thenew $45,000 replacement dining tables. That hurts the table manufacturer who does not need as many workers making the tables, so he lays off an excess employee. Perhaps the restaurant owner will decide to buy the replacement tables and instead lay off a waiter earning $45,000. Service will be slower, but the owner's family can pitch in to take up the slack — although this might not be necessary if business slows down because of the multiplier effect discussed below.
The unemployed housekeepers and waiters will have to make much larger cuts to their budgets. Not only are they eliminating the minor luxuries of life, such as eating out, but they also may have to eliminate essential items by selling their cars or moving out of their apartments and moving in with extended family. As a result, the people providing essential products and services have less money. They in turn make similar cuts to their staff, which results in additional unemployment. Economists refer to these secondary layoffs caused by lack of spending by the employees initially laid off as the multiplier effect.
If each taxpayer making more than $500,000 directly or indirectly reacted to the tax increase by laying off one employee, 1 million high-income taxpayers would react similarly by laying off 1 million people. Lower-income families hit by the tax increase would react similarly. With the multiplier effect, perhaps another million people would be laid off.
The impact of the $120 billion reduction in federal spending will have a similar impact. If only half the spending cuts are achieved by reducing $50,000-a-year employees, more than 1 million people will be laid off. These layoffs also will have a multiplier effect, leading to additional layoffs and higher unemployment.
Similar logic applies to the reduction of national income. If people are laid off, they spend less money on products and services. Businesses sell less and have lower income. The reduction in national business income and national employment will lead to a reduction of national income, roughly defined as gross domestic product. Reduced national income also has a multiplier effect, further reducing national income and employment.
The economists at the Congressional Budget Office estimate that this tax increase and spending cut could result in an additional 3 million Americans becoming unemployed. They also estimate that the country will have 2.9 percent less income to spend.
There is also a psychological aspect to the fiscal cliff. Many analysts think that individuals, investors and business owners in this country are in economic limbo because they are concerned about the fiscal cliff. The business and financial communities do not like uncertainty. They do not know whether the U.S. will go over the fiscal cliff and enter a recession. They prepare for the worst. Consequently, they save money and do not spend money today because in a recession, cash is king. If the fiscal cliff is eliminated, these individuals, businesses and investors might be more inclined to spend money. This would immediately help stimulate the economy.
The fiscal cliff is a direct result of the failed leadership of the Obama administration. The president created this problem by failing to get Congress to agree on a responsible fiscal policy and trying to put off the difficult tax and spending issues by "kicking the can down the road." President Obama rationalizes his responsibility for creating the fiscal cliff by saying that he wants to prevent a tax cut for the rich. He has stated clearly that he wants to raise taxes on the rich even if it does not stimulate the economy or create additional tax revenue because it is "the right thing to do." Isn't stimulating the economy to create jobs for Americans the right thing to do? A competent president would not tolerate a fiscal cliff during a tepid recovery.
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