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A combination of spending cuts and tax increases could bring the economy to its knees at the end of 2012. By our count, the economy must deal with nine significant fiscal events that will be automatically triggered by current law if Congress and the president take no action. Together these events create a perfect storm of contractionary tax and spending policies that could push the already fragile American economy back into recession. Fed Chair Ben Bernanke dubbed it a "fiscal cliff." The media calls it Taxmageddon.
Despite the stultifying economic effects of this government-induced uncertainty, the prospect of action anytime soon is close to nil. Congress and President Obama are gridlocked, and the coming election will only heighten tensions. The hope is that with a catastrophe looming and a tight deadline, the odds for achieving something will be slightly better when the lame-duck Congress convenes after the November 6 elections.
However, after the election Congress will be more dysfunctional than usual. Leadership is in flux. Hundreds of members are moving to new offices. Future committee assignments are unsettled. Many staff members are scrambling for new jobs. And retiring members are focused on their post-legislative careers. The most likely outcome is that the outgoing Congress will duck any major decision-making by passing a short-term extension (perhaps for three or six months) so that no major changes in law will be triggered on December 31.
The basic two-part fiscal prescription for the U.S. economy remains the same as it has been since the dark days at the end of 2008. Notwithstanding Republican claims that the 2009 Obama stimulus was a failure, as long as joblessness remains unacceptably high and interest and inflation rates are low, deficit reduction should be postponed to prevent a collapse in aggregate demand. That means the United States should avoid tax increases and spending cuts probably until the end of 2013, and perhaps longer if Europe's financial problems persist.
Once the economy is in the clear, the desperately needed deficit reduction should take effect. The federal government's long-term finances are unsustainable. The aging of society and rising healthcare costs will push spending on social programs to unprecedented levels. Controlling Medicare, Medicaid, and Social Security spending is the key to long-term deficit reduction. Unless the country moves even further to the political right, it is inconceivable that a deal to reduce those benefits will not include tax increases. Even though spending cuts would be harmful during a recession, agreement on a credible bipartisan plan for long-term deficit reduction would produce the immediate benefits of reducing uncertainty and improving financial stability.
View TaxAnalysts'® Martin Sullivan's opinion in its entirety on TAX.com.
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