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The Fiscal Cliff: Tax hikes and another possible economic crisis

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By: NathanielCopeland
on 2nd Mar,2015

Some have even started ignoring it. Here is a small but somewhat adequate walkthrough of what you need to know about the fiscal cliff.
The Fiscal Cliff: Tax hikes and another possible economic crisis


The run up to the November elections, the incessant campaigning by both the contending parties and the news channels spewing hour after hour of electoral statistics and projections had forcefully refocused America's attention on unemployment figures and battleground states.

November 6th saw the reelection of President Obama and an almost immediate return to normalcy in terms of what Americans are really interested in understanding. The words ‘fiscal cliff' has been making the headlines and every other economist around the country are drawing and expounding their own theories on how it would affect the American economy.

Lost amidst the sea of technical talk and carpet bombed with thousands of diverging versions of the fact, most Americans have little clue about what the fiscal cliff really means or how it will affect them. Some have even started ignoring it. Here is a small but somewhat adequate walkthrough of what you need to know about the fiscal cliff.

What is the fiscal cliff?

In 2011, when Congress decided to lift the debt ceiling, it was devised as a desperate move to alleviate the economic problems. The underlying idea was to reduce taxes in order to increase liquidity within the economy. The so called cliff is a set of tax hikes to the tune of $500 billion which would automatically kick in unless the current tax cuts and policies which are set to expire on the 31st of December, 2012 are upheld by the current administration.

When the debt ceiling was raised, Congress thought of the fiscal cliff as a measure through which the opposing parties would be forced to unite and reach a consensus on economic policies in order to avoid another economic crisis. The bad news is that both parties are still in disagreement over taxation policies.

How is the fiscal cliff going to affect the economy?

In case the Congress fails to reach a consensus on how to deal with the looming fiscal issue at hand, the economy stands to be drained of billions by the spending cuts and tax hikes which are imminent. Moreover, unemployment would be on the rise since companies backed by Federal funding (which would by then be withdrawn) would have to start downsizing to cope with the loss in revenue.

On top of everything, the country's credit rating would have to be downgraded by the three big rating companies consisting of Standard & Poor's, the Fitch Group and Moody's. Although economists are somewhat reluctant to concretely declare how the downgraded international credit rating would affect the average citizen, there could be one direct foreseeable effect.

If the Federal creditworthiness takes a hit, it would of course lead directly to increased cost of borrowing or in simpler terms, greater risk premium. This would have a domino effect and would lead to an increase in all other interest rates like those levied on car loans and mortgages which in turn would affect the general population at large.

The only possible solution to avoid taking the turn towards another economic crisis on a massive scale would be for congress to reach a consensus about tax rates and more importantly, spending cuts which would move towards stabilizing the economy in the long run.

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