The USAs Fiscal Cliff Deal: What Does it Mean?

On the Tuesday just gone, New Years Day, US lawmakers passed a bill designed to help avoid the looming fiscal cliff.

What does this bill do?

According to an article from the NBR, the bill:

  1. Permanently raises tax rates on income over USD$400,000 for individuals and USD$450,000 for couples filing jointly. The new rate is 39.6%, which is up from 35%. The people impacted by this make up less than 1% of the US population.
  2. Raises taxes on capital gains and dividends for those (aforementioned) households, from the current 15% to roughly 20%.
  3. Limits the value of personal tax exemptions, as well as the value of itemised tax deductions. These two restrictions kick in at USD$250,000 for individuals and USD$300,000 for couples.
  4. Sets the estate tax rate at 40% on estates valued at over USD$5 million, which is an increase from the 35% that currently applies to those valued at over USD$5.12 million.
  5. Reinstates a two-percentage-point payroll-tax cut that was part of a deal President Barack Obama struck with Republicans late in 2010. This restores the employee portion of the Social Security tax to 6.2%.
  6. Extends a number of tax breaks for families of modest means.
  7. Delays for two months part of the USD$110 billion in spending cuts that otherwise would have taken place in early January.

According to an article from Reuters, spending “cuts of $109 billion in military and domestic programs were only delayed for two months.”

The bill will, at least in theory, raise roughly USD$600 billion in new revenue over 10 years, which is less than 20% of the revenue that would have come in if all the tax breaks had expired.

What impact will this have?

This deal has been of a much smaller size than either party had earlier anticipated. (At least initially, according to Reuters, “the house speaker [John Boehner] had sought to negotiate a “grand bargain” with Obama to overhaul the U.S. tax code and rein in health and retirement programs that are due to balloon in coming decades as the population ages.”) Because of this, they were unable to address some large issues that are likely to reappear in the future.

This will likely increase the level of US public debt a bit compared to what the debt level would be if spending cuts had been included in this bill, though it probably won’t increase the debt too substantially (at least relative to where it is already). Because of this, it could also make it more difficult than it already is for the US to pay off its debt in the future.

Are spending cuts necessary?

At the moment, the US has a very large amount of federal debt. According to Wikipedia (at the time of writing), the total US public debt as at December 13th 2012 was USD$16.37 trillion, which is more than 100% of the US GDP in 2011, which was USD$14.99 trillion. I am unable to find any figures for the US GDP in 2012 unfortunately, so I can’t use 2012 GDP figures.

In comparison, the level of Greek public debt in 2011 was estimated to be 165% of GDP.

As the US spends more money, they need to borrow more to finance that spending, because the money needs to come from somewhere. As a result of this, the level of public debt increases. Thus, I believe that the US does need to cut spending to avoid increasing the level of public debt, or at least to avoid increasing too much higher than it is already. I believe that the current level of public debt in the US is already at an unsustainable level, so worrying about the debt becoming unsustainable is pointless. I believe that a debt level anywhere near 100% of GDP is unsustainable, as the debt needs repaying and ‘serviced’ (which refers to the interest on the debt), and a country needs to earn money to do that. Borrowing to repay debt is, in my opinion, irresponsible.

Where could the US cut public spending?

The US budgeted for USD$925.2 billion dollars to be spent on defence, USD$866.1 billion to be spent on health care, and USD$805.6 billion to be spent on pensions in the 2012 financial year (the financial year from October 1st 2011 to September 30th 2012), according to figures from USGovernmentSpending.com. While these figures may vary from actual spending, they likely won’t vary too much from what was actually spent in these areas.

I believe that defence spending would be a good place to start cutting public spending, as a lot of the US military operations, such as those in areas of the Middle East, are much bigger than they need to be (at least in my opinion). As a side note, there might be some in positions of power who want the US to increase military action against Iran (that may just be speculation, but there is, I believe, at least some evidence to support that).

The House Speaker, John Boehner, at least initially aimed to make a bargain with President Obama, aiming to “rein in health and retirement programs” according to Reuters. That’s a start, though it may not have eventuated this time around, but at least there is the intention to do something within the US Parliament.

Summary (because this post is quite long)

The bill that those in power have passed increased some taxes that will impact the wealthy, while extending tax breaks for those of modest means. There were no spending cuts in this bill, though some did intend to address spending cuts in this bill. This will just postpone when those in power will address any potential spending cuts.

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