Indian Capital Markets in reaction to the global sentiments affected by the much said major issue of Fiscal Cliff in US. But the buzzing question is what is Fiscal Cliff and what will be the material impact in global as well as Indian markets.
Let us find what is "Fiscal Cliff" ?
Let us find what is "Fiscal Cliff" ?
The Fiscal Cliff Explained
“Fiscal cliff” is the popular shorthand term used to
describe the conundrum that the U.S. government will
face at the end of 2012, when the terms of the Budget
Control Act of 2011 are scheduled to go into effect.
Among the laws set to change at midnight on December
31, 2012, are the end of last year’s temporary payroll tax
cuts (resulting in a 2% tax increase for workers), the end
of certain tax breaks for businesses, shifts in the
alternative minimum tax that would take a larger bite, a
rollback of the "Bush tax cuts" from 2001-2003, and the
beginning of taxes related to President Obama’s health
care law. At the same time, the spending cuts agreed
upon as part of the debt ceiling deal of 2011 will begin to
go into effect. According to Barron's, over 1,000
government programs - including the defense budget
and Medicare are in line for "deep, automatic cuts."
In dealing with the fiscal cliff, U.S. lawmakers have a
choice among three options, none of which are
particularly attractive:
- They can let the current policy scheduled for the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – go into effect. The plus side: the deficit would fall significantly.
- They can cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe. The flip side of this, of course, is that the United States' debt will continue to grow.
- They could take a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth.
Can a Compromise be Reached?
The oncoming fiscal cliff is a concern for investors since
the highly partisan nature of the current political
environment could make a compromise difficult to reach.
This problem isn't new, after all: lawmakers have had
over a year to address this issue, but Congress – mired
in political gridlock – has largely put off the search for a
solution rather than seeking to solve the problem
directly. In general, Republicans want to cut spending
and avoid raising taxes, while Democrats are looking for
a combination of spending cuts and tax increases.
Although both parties want to avoid the fiscal cliff,
compromise is seen as being difficult to achieve –
particularly in an election year. Currently, it appears that
a meaningful deal won't be reached until after the
December 31 deadline.
The most likely outcome is another set of stop-gap
measures that would delay a more permanent policy
change. Still, the non-partisan Congressional Budget
Office (CBO) estimates that if Congress takes the middle
ground – extending the Bush-era tax cuts but cancelling
the automatic spending cuts – the result, in the short
term, would be modest growth but no major economic
hit.
Possible Effects of the Fiscal Cliff
If the current laws slated for 2013 went into effect
permanently, the impact on the economy would be
dramatic. While the combination of higher taxes and
spending cuts would reduce the deficit by an estimated
$560 billion, the CBO also estimates that the policy would
reduce gross domestic product (GDP) by four
percentage points in 2013, sending the economy into a
recession (i.e., negative growth). At the same time, it
predicts unemployment would rise by almost a full
percentage point, with a loss of about two million jobs.
A Wall St. Journal article from May 16, 2012 estimates the
following impact in dollar terms: “In all, according to an
analysis by J.P. Morgan economist Michael Feroli, $280
billion would be pulled out of the economy by the
sunsetting of the Bush tax cuts; $125 billion from the
expiration of the Obama payroll-tax holiday; $40 billion
from the expiration of emergency unemployment
benefits; and $98 billion from Budget Control Act
spending cuts. In all, the tax increases and spending
cuts make up about 3.5% of GDP, with the Bush tax cuts
making up about half of that, according to the J.P.
Morgan report.” Amid an already-fragile recovery and
elevated unemployment, the economy is not in a position
to avoid this type of shock.
The Term "Cliff" is Misleading
It's important to keep in mind that while the term “cliff”
indicates an immediate disaster at the beginning of 2013,
this isn't a binary (two-outcome) event that will end in
either a full solution or a total failure on December 31.
There are two important reasons why this is the case:
1) If all of the laws went into effect as scheduled and
stayed in effect, the result would undoubtedly be a return
to recession. However, Congress continues to work
toward a deal that will alleviate the effects in some form.
The chances that such a deal won't be reached at some
point are slim.
2) Even if the deal does not occur before December 31,
as appears likely, Congress can - and almost certainly
will - act to change the scheduled laws retroactively to
January 1 after the deadline.
At he same time, even a solution isn't
necessarily positive, since a compromise
will likely to involve higher taxes or
reduced spending in some form- both of
which would help reduce the debt but
would be negative for economic growth.
With this as background, it is important to
keep in mind that the concept of "going
over the cliff" is largely a media creation
since even a failure to reach a deal by
December 31st doesn't means that a
recession and financial markets across the
globe will crash.....
