What is a Fiscal Cliff?

By Jason Fittler

The term “fiscal cliff” is used to describe several big fiscal events set to occur in the U.S. at the end of this year and in early 2013.

Among them:

  • The expiration of the Bush-era tax cuts at the end of 2012, including current lower tax rates on capital gains, dividends, income, and estates, as well as number of other measures.
  • The expiration of fiscal stimulus measures, such as the payroll tax cut and extended unemployment benefits.
  • Spending cuts scheduled to be triggered automatically in January 2013 as a result of the failure of the deficit reduction super committee last year.

Depending on estimates, the impact of all these actions taken together would be a fiscal shock on the order of $300 billion to $600 billion in just one year.

Such policies would reduce the budget deficit and begin to address the nation’s increasingly worrisome debt situation. However, economists generally agree that allowing the fiscal cliff to take effect in full, at the same time, could have a substantially negative impact on the economy in 2013.

The timing of these changes also coincides with the US election being held on the 06/11/2012, putting the issue in the hands of a new administration and Congress. In my view this will have an affect on the market in the short-term.

At present we are expecting that the market will pull back as we head towards the end of the year the “Fiscal Cliff” is one of the major fundamental issues which will affect the market.

I expect that this issue will most likely be deferred once the election is over to give some breathing space.

The concern will be around how tight the election will be.

To me this indicates that the US market is set to pull back as investors look to sit on the side lines and wait to see the results.

This will have an effect on the Australian markets and points to a pullback we have been expecting.