The non-partisan Congressional Budget Office (CBO) warned Wednesday, that unless bickering politicians get their act together, nearly $500 billion in spending cuts and tax hikes would kick in from January. Over 10 years these policies could take almost $7 trillion out of the economy.
This assault on the federal budgetary deficit is also known as a fiscal cliff, a phrase coined by Fed Chairman Ben Bernanke.
The main facets of this cliff would be a withdrawal of tax cuts, protection from Minimum Alternate Tax, abolishment of various kinds of tax concessions, and massive cuts in both defense and non-defense sector spending. A temporary payroll tax break and emergency unemployment benefits would also get the chop.
According to the CBO, the combined effect of the cliff would likely plunge the U.S. into a recession and push up unemployment to record levels – in other words a financial apocalypse. The agency warns that “businesses” and consumers “concern about the scheduled fiscal tightening will lead them to spend more cautiously than they otherwise would have” during the remainder of 2012.
The CBO warning has only led to more finger-pointing amongst the politicians, and no solution appears possible before the elections. A temporary reprieve might be obtained by postponing the spending cuts and relaxing the tax policies again, but this would only result in a higher fiscal deficit, and government debt could reach unsustainable levels.
“[I]f no action were to be taken, the size of the fiscal cliff is such that there’s I think absolutely no chance that the Federal Reserve … could or would have any ability whatsoever to offset … that effect on the economy,” Bernanke said a few months ago.
Among sectors that could be affected by the spending cuts, the defense sector is the most vulnerable. Companies such as Lockheed Martin Corporation (NYSE:LMT) and other large defense contractors may have to cut back on hiring and lay-off workers. To comply with a 60-day notice period under labor laws, they may have to issue lay-off notices in November in case the cliff takes effect from January 1st.
Spending cuts have led companies to merge or acquire other companies, such as the recent merger between satellite imaging companies, DigitalGlobe Inc (NYSE:DGI) and GeoEye Inc. (NASDAQ:GEOY).
The resultant recession from the cliff would severely affect retail spending and automakers and the recent recovery in the housing market would likely dry up. The fall in economic activity would take a severe toll on bank’s incomes and increase the bad loans on their books.
It is all up to Congress now, where undoubtedly members are far more concerned about their re-election than taking action.