The Fiscal Cliff

It was in mid-2000, with a Democratic president and a Republican-controlled House and Senate, that the federal government of the United States was last able to pass a budget which would result in a surplus—the fourth in a row  (Office of Management and Budget 2013). Notwithstanding that these surpluses were largely made possible by the economic opportunities and tax revenues generated by a rapidly growing economy and the dot-com bubble, and only secondarily by the extra revenue brought in through higher top-end income tax rates, capital gains tax rates, and corporate tax rates enacted by President Clinton during his first term, and notwithstanding that the total US public debt outstanding ($5,727,776,738,304.64 on the day Bill Clinton left office) actually rose from $5.42 trillion to $5.8 trillion over those fiscal years, this was nonetheless a period of economic prosperity for the country  (U.S. Department of the Treasury, Bureau of the Public Debt 2013). [1]

Fast-forward eleven years, and America found itself facing what Federal Reserve Chairman Ben Bernanke termed a “fiscal cliff”—a potential confluence in January 2013 of the expiry of a number of tax cuts and credits including the Bush tax cuts and the 2010 payroll tax cut, and the implementation of across-the-board spending cuts, or 'sequestration', worth $1.2 Trillion over ten years ($503 Billion in the 2012 fiscal year) as mandated by the Budget Control Act of 2011  (The Hill 2012, National Council of State and Housing Agencies 2012, Council On Foreign Relations 2012). The precipitous language used to describe this scenario referred not to the mere confluence itself, but rather to the economic consequences which many predicted: a drop in output of between 2.2% and 2.9%, contributing to a 0.5% year-over-year decrease in inflation-adjusted GDP and pushing the unemployment rate back above 9%  (Congressional Budget Office 2012, The World Bank 2012).[2]

History and implications

In mid-2000 the dot-com bubble, which had fueled much economic growth and had helped the federal government to (sort-of) balance its books, burst. The stock market, which had been heavily buoyed by the over-valuation of many internet start-ups, crashed. Growth remained positive but feeble through the end of the Clinton presidency, then dipped into negative territory during the first quarter of 2001, when Republican George W. Bush moved into the White House  (Trading Economics 2012). Faced with a struggling economy and possibly motivated by ideology, President Bush would quickly sign into law a number of tax cuts. The first, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), lowered income tax rates across the board, and offered tax relief on retirement plans, capital-gains, and estate inheritances, among other things  ( n.d.). The second, the Jobs and Growth Tax Relief Reconciliation Act of 2003, extended many of the rate cuts in EGTRRA and reduced or eliminated many of the phase-in periods which had been built in to EGTRRA  ( n.d.). Built into these Acts—which together came to be known as ‘the Bush tax cuts’—was a sunset clause which mandated their provisions back to pre-2001 levels in 2010.

Yet 2010 did not see the end of the Bush tax cuts. While they were responsible for adding over $1.5 trillion to the federal debt from 2002-2011, and while the total US public debt outstanding had ballooned from $5.7 to $10.6 trillion during the Bush presidency, and to over $12.3 trillion by the beginning of 2010, the US economy was in sufficient danger of falling back into recession should the tax cuts expire that Congress and the White House both  opted to extend them for two years and throw in a one-year payroll tax cut for good measure, all as a part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010  (Congressional Budget Office 2012, Internal Revenue Service 2013).

Having thus sidestepped a possible double-dip recession, legislators watched as the federal debt continued its upward march—to over $14 trillion by the end of 2010  (U.S. Department of the Treasury, Bureau of the Public Debt 2013). In early 2010 Congress had approved an increase in the debt ceiling, the maximum amount of debt which can be legally issued by the US Treasury, to $14.294 trillion, and that limit was fast approaching (The Library of Congress 2010). Failure to ultimately raise the ceiling would have left the government unable to meet its financial obligations, such as Social Security payments or salaries for federal employees, would likely have crashed the stock market, and almost certainly would have led it to default on its debt obligations. Yet the US Constitution grants Congress alone the power to borrow money on the credit of the United States, and the Republican-controlled House was not keen to permit the debt to continue rising  (National Archives n.d.). As a means of checking its upward progress, Republicans demanded deep spending cuts in exchange for a higher debt ceiling—yet they were loth to allow those cuts to affect military spending or to allow tax increases as a further check on the ballooning debt. Democrats, including President Obama, were equally loth to permit deep cuts to entitlement programs such as Social Security, Medicare, and Medicaid. Both sides ultimately agreed to a last-minute deal which realized $917 billion in savings over ten years through caps on discretionary spending, and which mandated the establishment of a bipartisan ‘super committee’ which was supposed to agree upon at least $1.2 trillion in further cuts over ten years by November of 2011  (Council on Foreign Relations 2011, National Council of State and Housing Agencies 2012). Central to the deal was a provision which would automatically trigger across-the-board sequestration beginning in January 2013 if the super committee could not agree on cuts, which they could not.

It quickly became clear that the Bush tax cuts were due to expire, sequestration was due to begin, and the payroll tax cut—which had been extended until the end of 2012—was due to expire, all at once and around the same time the Treasury was likely to again bump up against the new debt ceiling of nearly $16.4 trillion. And yet, for all the immediate danger this ‘fiscal cliff’ posed to the fragile economic recovery, and for all the long-term danger posed by the current combination of spending commitments and tax rates, political cowardice and partisan rancour prevented any sort of solution being reached throughout 2012.

On January 1, 2013, Congress passed the (prematurely named) American Taxpayer Relief Act of 2012. The Act largely kicked the can down the road by postponing for two months the sequestration of the Budget Control Act, though it did make permanent the Bush income tax cuts for all but the top-earning 1% of households—individuals earning at least $400,000, or married couples earning at least $450,000—and closing a few tax loopholes for individuals earning more than $200,000  (Council On Foreign Relations 2013). The payroll tax cut was allowed to expire. The overall result is expected to be a 1-1.5% contraction in output, though this doesn’t account for any further contraction which will almost certainly result from wrangling over the debt ceiling and whatever cuts eventually happen, nor does it do much at all to address the long-term fiscal issues facing the government  (The Economist 2013). Thus the threats posed by the ‘cliff’ largely remain, in principle if not in name. [3]

And America is not the only nation being threatened. The size of the American economy means that as it goes, so often does the rest of the planet. Assuming the more conservative estimate of a 2.2% decline in US GDP growth resulting from the ‘cliff’, the World Bank estimates a decrease US imports by nearly 5%, stunting world trade by 1.5%. Rich countries as a whole could expect a decline in GDP of over 1%, while the effect on most less developed countries would be slightly less severe  (The World Bank 2012).[4]  As the largest trading partner of the US by value, Canada would be particularly affected  (US Census Bureau 2012). Modest estimates suggest the fallout from the ‘cliff’ would stunt Canada’s growth by 0.5-0.7%, based on a hit of 1.5% to US growth  (TD Economics 2012).

Is there a role for monetary policy in resolving the issues?

When Ben Bernanke termed the mess a “fiscal cliff”, he was indicating, among other things, that it required resolution through changes in fiscal policy. With short-term interest rates already at zero, and with the Fed already involved in its third round of ‘quantitative easing’, there simply isn’t much more the Fed can do to stimulate the economy—indeed, St. Louis Federal Reserve President James Bullard called the potential effects of the fiscal cliff “just too big” for the Fed to counteract  (Irwin 2012, Bull and Dalgleish 2012) . In any case, monetary solutions would at best be a stop-gap, the issues being so heavily rooted in fiscal dysfunction. The debt-ceiling and sequestration issues which loom, and the absence of a long-term plan to reign in entitlement spending, can be dealt with by legislators alone, and that will require a level of bipartisan cooperation unseen in recent years.


Bull, Alister, and James Dalgleish. "Fed's Bullard: monetary policy cannot save U.S. from fiscal cliff." Reuters. December 2, 2012. (accessed January 10, 2013).

Congressional Budget Office. "Economic Effects of Policies Contributing to Fiscal Tightening in 2013." Congressional Budget Office. November 2012. (accessed January 9, 2013).

—. "" Congressional Budget Office. June 7, 2012. (accessed January 9, 2013).

Council On Foreign Relations. "American Taxpayer Relief Act of 2012, January 2013." CFR. January 2, 2013. (accessed January 9, 2013).

Council on Foreign Relations. "Congressional Research Service: The Budget Control Act of 2011: Effects on Spending Levels and the Budget Deficit." CFR. October 5, 2011. (accessed January 9, 2013).

Council On Foreign Relations. "What Is the Fiscal Cliff." CFR. December 12, 2012. (accessed January 10, 2013). H.R. 1836 (107th): Economic Growth and Tax Relief Reconciliation Act of 2001. n.d. (accessed January 10, 2013).

—. H.R. 2 (108th): Jobs and Growth Tax Relief Reconciliation Act of 2003. n.d. (accessed January 10, 2013).

Internal Revenue Service. "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010: Information Center." IRS. January 7, 2013.,-Unemployment-Insurance-Reauthorization,-and-Job-Creation-Act-of-2010:-Information-Center (accessed January 10, 2013).

Irwin, Neil. "If we go off the fiscal cliff, the Fed can’t save us." The Washington Post. December 5, 2012. (accessed January 10, 2013).

Krugman, Paul. The Forgotten Millions. December 6, 2012. (accessed January 10, 2013).

National Archives. "Transcript of the Constitution of the United States - Official Text." National Archives. n.d. (accessed January 10, 2013).

National Council of State and Housing Agencies. "Budget Control Act of 2011 One Page Summary." NCSHA. April 18, 2012. (accessed January 10, 2013).

Office of Management and Budget. "Historical Tables." The White House. 2013. (accessed January 10, 2013).

Schroeder, Peter. "Bernanke warns lawmakers country headed for 'massive fiscal cliff'." The Hill. February 29, 2012. (accessed January 10, 2013).

TD Economics. "TD Economics Data Release: The U.S. Fiscal Cliff and What It Means for Canada’s Economy." TD. 2012. (accessed January 10, 2013).

The Economist. "Nothing to be proud of." The Economist. January 5, 2013. (accessed January 9, 2013).

The Library of Congress. Bill Summary & Status 111th Congress (2009 - 2010) H.J.RES.45 CRS Summary. February 4, 2010. (accessed January 10, 2013).

The World Bank. "US fiscal cliff: Implications for global outlook in 2013." September 17, 2012. (accessed January 10, 2013).

Trading Economics. "United States GDP Growth Rate." Trading Economics. 2012. (accessed January 10, 2013).

U.S. Department of the Treasury, Bureau of the Public Debt. The Debt to the Penny and Who Holds It. 2013. (accessed January 10, 2013).

US Census Bureau. "Foreign Trade - U.S. Top Trading Partners." US Census Bureau. November 2012. (accessed January 10, 2013).

[1] The total public debt outstanding is a measure of both debt held by the public and intragovernmental holdings (owed by the government to itself). The first decreased over these years, while the second increased, allowing for a simultaneous ‘budget surplus’ and an increase in the total public debt outstanding.

[2] It’s worth noting that some Economists, such as Paul Krugman, reject the proposition that the fiscal cliff is a problem, or that there even is such a ‘cliff’  (Krugman 2012).

[3] The impact of these threats may be less severe than predicted, given the deal reached on the Bush tax cuts.

[4] See note 3.