Q. What is the fiscal cliff?
A. The term refers to more than $500 billion in tax increases and across-the-board spending cuts scheduled to take effect after Jan. 1 — for fiscal year 2013 alone — unless Mr. Obama and Republicans reach an alternative deficit-reduction deal. Ben Bernanke, the chairman of the Federal Reserve, who is not known for catchy phrases, coined the metaphor “fiscal cliff” last winter to warn of the dangerous yet avoidable drop-off ahead in the nation’s fiscal path. It stuck.
Q. If we go over this so-called cliff, what happens?
A. Taxes would rise for nearly every taxpayer and many businesses. Financing for most federal programs, military and domestic, would be cut. Many economists say that while annual budget deficits are too high, these new taxes and spending cuts would be too much deficit reduction, too suddenly, for a weak economy. More than $500 billion equals roughly 3 percent to 4 percent of gross domestic product. The Congressional Budget Office has said the result would be a short recession, though some analysts say the measures could be managed so they do less damage. “Slope,” they argue, is a better metaphor than cliff.
Q. Exactly what tax increases are in store?
A. When a tax cut expires, the practical effect is a tax increase. And a slew of tax cuts — $400 billion for 2013 — expire on Dec. 31: All of the Bush-era rate reductions; smaller tax cuts that periodically expire for businesses and individuals; and the 2-percentage-point cut in payroll taxes that Mr. Obama pushed in 2010, which increased an average worker’s take-home pay by about $1,000 a year.
Also, 28 million taxpayers — about one in five, all middle- to upper-income — would have to pay the alternative minimum tax in 2012, raising their taxes more. That is because Congress has failed to pass an inflation adjustment, as it usually does, to restrict the number of taxpayers subject to the alternative minimum largely to the affluent.
Q. What spending would be cut?
A. An emergency unemployment-compensation program is expiring, which would save $26 billion but end payments to millions of Americans who remain jobless and have exhausted state benefits. Medicare payments to doctors would be reduced 27 percent, or $11 billion, because this year Congress has not passed the usual so-called “doc fix” to block the cuts, which otherwise are required by a 1990s cost-control law.
The biggest cut would be $65 billion, enacted across the board for most federal programs over the last nine months of fiscal year 2013, from January through September. This cut, known as the sequester, was mandated by an August 2011 budget deal between Mr. Obama and Congress that ended their standoff over raising the nation’s debt limit. In that deal, they agreed to reduce spending by $1 trillion over 10 years and to identify an additional $1.2 trillion in savings by January 2013. If they fail to agree on the second installment — as is the case so far — the automatic cuts will kick in.
Q. Why did the parties create such a fiscal and economic threat?
A. It was part intentional, part coincidental.
The intentional: Since Ronald Reagan’s administration, with mixed results, presidents and Congresses have occasionally mandated a self-imposed future crisis to force themselves to agree on unpopular tax and spending actions. In that spirit, the idea behind the August 2011 deal was that Republicans would so greatly fear the military cuts, and Democrats the domestic spending cuts, that they would negotiate a deficit-reduction alternative by the Jan. 1 deadline.
The coincidental: The measures from the 2011 deal are set to take effect at the same time as the changes to jobless benefits, the alternative minimum tax adjustment and the Medicare “doc fix” — a confluence that the two parties did not fully expect back in August 2011. The nation will also reach its debt ceiling in January, creating additional uncertainty. Accounting maneuvers by the Treasury Department could push that deadline to March, but Mr. Obama wants a debt-limit increase as part of any deal, adding another item to the agenda.
Q. Can’t Democrats and Republicans agree on anything here?
A. They actually agree on a lot. Neither side favors the sequester, an expanded alternative minimum or Medicare cuts for doctors; the issue in preventing those outcomes is where to find offsetting savings to avoid adding to annual deficits. And both parties want to extend all of the Bush tax cuts for 98 percent of taxpayers — on income below $250,000 for couples and on income below $200,000 for individuals.
Their main disagreement is a familiar one: the Bush rates on income above that, for the top 2 percent of taxpayers. Mr. Obama campaigned against the rates in 2008 and in 2012. In December 2010, when the Bush tax cuts originally were to expire, Mr. Obama reluctantly agreed to extend all of them for two years in exchange for Republicans’ support for the temporary payroll tax cut and extended jobless aid. This time, he swears, is different.
Q. If the president extended all the Bush rates once, why wouldn’t he do so again for the right concessions?
A. The economy was weaker in 2010, and so was Mr. Obama. Republicans had just triumphed in the midterm elections, taking control of the House. Now Mr. Obama is fresh off re-election, and Congressional Democrats have gained seats. He vows that he will not allow the top tax rate to stay at 35 percent; a return to 39.6 percent would raise about $1 trillion over 10 years. Chastened Republicans have suggested they would support higher revenues, but only from limiting tax deductions for high-income taxpayers, not from higher rates. Mr. Obama has not ruled out a compromise that would limit deductions as well as setting the top rate above 35 percent but below 39.6 percent.
Q. What now? Might they really reach an impasse?
A. No one knows. Despite market jitters about that outcome, Democrats suggest that they are willing to let Jan. 1 come and go without resolution unless Republicans relent on the top rate. That could simply be bargaining bravado, to make Republicans blink. A Washington Post-Pew Research Center poll this week found that a majority of Americans would blame Republicans for failure.
Q. Is there a best-case outcome here?
A. Many budget experts and economists are hoping for a two-part deal. The first part would extend many of the tax cuts and repeal the automatic spending cuts to avert the changes scheduled after Jan. 1. But it would be contingent on the second part: a framework for reducing projected long-term deficits by overhauling both the tax code — to raise revenues — and entitlement programs — chiefly Medicare and Medicaid, whose rising costs in an aging population are unsustainable. Those overhauls would preoccupy Mr. Obama and Congress through 2013 and perhaps 2014.
Such an agreement would set specific targets for new tax revenue and spending cuts to reduce deficits by about $4 trillion over a decade, giving Congress and the president more time to work out the details. If they failed to do so, presumably other automatic changes might be in store as an enforcement action — setting up yet another looming deadline for the future.
By Jackie Calmes