Bloomberg's Guide To The Fiscal Cliff Is The Best We've Seen

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Photo: Steve Wilson via Flickr

The ‘fiscal cliff’ – the $607 billion in tax and spending provisions set to expire at the end of the year – is fast approaching.And this is expected to impose fiscal restraint and hurt GDP growth.

Current consensus of economists polled by Bloomberg is for 2 per cent 1.9 per cent growth in the first quarter of 2013, and 2.3 per cent growth in the second quarter.

But if Congress fails to act this could slow to 1 per cent in the first half of the year. And real GDP is projected to fall to -2.2 per cent in the first quarter, and -1.3 per cent in the second quarter.

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This is likely to cause higher unemployment, declining tax revenue and a mild recession in early 2013.

In fact, the ‘fiscal cliff’ has already caused firms to cut back on investments and hiring, and has prompted consumers to save more adding to the slow economic recovery. But addressing these policy choices now is critical to the long-term health of the U.S. economy.

We drew on Bloomberg BRIEF Economics’ new special ‘fiscal cliff’ report to breakdown the components of the fiscal cliff.

The charts show how the tax cuts and spending changes are expected to impact the U.S. economic outlook, carefully examining the policy uncertainty that has investors concerned.

This breakdown shows the estimated impact of tax and spending changes that are part of the 'fical cliff' in billions of dollars

A stalemate after the elections and the failure of Congress to act will send the economy into a recession in the first half of 2013

Rising entitlement spending has caused business investment – important for increased productivity and higher living standards – to fall.

Spending on entitlements has surged to an estimated 13.5 per cent of GDP in 2012, while business investment is down to an estimated 1.7 per cent.

Periods of GDP growth rate and higher living standards have correlated with periods of greater investment.

Higher entitlement spending would cause the government to tap the limited amount of capital held by private savers and thereby limit capital available for businesses. Here are some details on entitlement spending:

  • Federal spending on mandatory entitlements is projected to increase from $2 trillion in 2012, to $2.8 trillion in 2017.
  • Spending on entitlements as a per cent of GDP has increased from 4.9 per cent in 1962, to a projected 13.5 per cent in 2012.
  • Meanwhile, net fixed business investment is projected to decline to 1.7 per cent in 2012, down from 3 per cent in 1962.

Source: Bloomberg BRIEF Economics

Money paid out by the government as part of unemployment benefits is declining. The CBO estimates that each dollar of unemployment insurance is estimated to generate $1.55 in economic activity.

Sequestration is expected to slash $55 billion in defence and non-defence spending. This will cause massive job losses in the defence contractor industry.

The end of Bush tax cuts would cut consumer spending by $200 billion or 1.3 per cent of GDP. The end of the Obama Tax holiday will cut 0.6 per cent from GDP.

Individual taxes have come down, but corporate taxes have not. The U.S. has a combined government corporate tax rate of 39 per cent, higher than Japan, France and Germany.

To stabilise debt-to-GDP levels the government has to decrease outlays or increase revenue, or possibly by doing both.

Nearly half of the automatic sequestration under the fiscal cliff is expected to come from discretionary spending.

Federal spending as a per cent of GDP is projected to rise to 24.2 per cent in 2022, from 24.1 per cent in 2011.

The Senate currently has 51 Democrats and 47 Republicans. During the upcoming election seven seats are at risk, six held by Democrats, and one held by Republicans.

The House currently has 192 Democrats and 240 Republicans. 28 House races are currently a toss-up according to Roll Call.

Fed chairman Ben Bernanke has said the Fed lacks the tools to offset a shock from the 'fiscal cliff'.

Ben Bernanke has said the Fed doesn't have the tools necessary to stave off the impact of a major fiscal shock. It is likely to extend low interest rates and restart the purchases of long-term securities.

The Fed might use the December 12 FOMC meeting to announce that it is lengthening its maturity extension program to offset the impact of the fiscal cliff.

Source: Bloomberg BRIEF Economics

Goldman Sachs expects the S&P 500 to fall after the election as investors face the 'fiscal cliff'.

'We expect S&P 500 will fall sharply following the election when investors finally recognise the serious possibility that the 'fiscal cliff' problem will not be solved in a smooth fashion. Goldman Sachs assigns a one-in-three likelihood Congress does not address the situation before Jan 1st. In contrast, our conversations suggest the vast majority of clients expects the 'fiscal cliff' issue will be addressed during the lame duck session of Congress.

Richard Koo reiterates Bernanke's call that the U.S. economy will not escape unscathed from the 'fiscal cliff'.

Now see what's behind China's economic slowdown...

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