US Fiscal Cliff Deal 2012

1 US FISCAL CLIFF DEAL
US FISCAL CLIFF DEAL:
A SOLUTION OR A PROBLEM
RACHITA BHATTACHARYA [ECONOMICS (H) 3rd
Yr.]
NAMAN RASTOGI [B.COM (H) 2nd
Yr.]
SHRI RAM COLLEGE OF COMMERCE

ABSTRACT
The research is based on the ongoing fiscal cliff in the US which is the popular short hand term
to describe the expiry of tax breaks and introduction of spending cuts leading to the conundrum
that the US government faced at the end of 2012.
While writing this research paper, we have tried to explain each and every clause along with its
implication in the simplest yet apprehensible manner. We proceeded in a systematic approach by
describing the intricate fiscal enigma to provide optimum understanding of the subject matter.
We have tried to analyse both pros and cons of the strategies adopted by the US government and
have given a perspective on envisioned socio-economic inequalities conceived by the deal.
Further, it throws light upon different sectors of the US economy affected by the deal and their
projected growth trend in the subsequent years. As we approach to the end of the research paper,
we have tried to cluster the implications of the deal in a nutshell and have justified its
comportment.

CONTENT
1) INTRODUCTION 4
 Figure 1: Timeline-Marching Towards the Fiscal Cliff
 Passing of the Fiscal bill
2) THE FISCAL DEAL-BEGINNING OF THE NEW ERA 7
 The end of last year payroll tax cuts from March 2013
 Figure 2: Laffer Curve
 The end and renewal of Tax Breaks for Businesses
 Figure 3: State, Local and Federal taxes by income group
 Figure 4: Total Tax Bill, by Income group
 Shifts in the AMT slabs
 Table 1: AMT Slab
 Figure 5: Comparing AMT curves
 Sequestration
 Figure 6: Sequester Cuts
 Table 2: Mechanics of Sequestration
 Table 3: Discretionary Spending Cap
 The beginning of Obama Health Care Law from 1st
January, 2014 (expected date)
 Figure 7: Sources of Insurance in the US
3) EFFECTS ON VARIOUS SECTIONS OF THE US ECONOMY 24
4) CONCLUDING REMARKS 26
 Figure 8: Alternative Scenario 1
 Figure 9: Alternative Scenario 2
5) REFERENCES 30

INTRODUCTION
―Under current law, on January 2, 2013, there‘s going to be a massive fiscal cliff of large
spending cuts and tax increases‖ said Ben Bernanke (Federal Chief), in the testimony to the
House Financial Service Committee on 29 Feb 2012. ―Fiscal Cliff‖ is the popular shorthand term
used to describe the conundrum that the U.S. government faced at the end of 2012, when the
terms of the Budget Control Act of 2011 are scheduled to go into effect.
The whole process kick-started in August 2011 with the signing of the Budget Control Act.
The law involved creation of the Congressional Joint Select Committee on Deficit
Reduction (also called Super Committee) to propose options for budget amendment and reduce
the deficit by at least $1.2 trillion over 10 years. The provisions of BCA in a nutshell were:
 The debt ceiling was increased $400 billion immediately.
 The president could request further increase of $500 billion subject to Congressional
motion, which the president may veto. In case of disapproval, 2/3 majority is required to
override veto.
 The bill directly stated for at least $917 billion cuts over the next 10 years in exchange of
the initial increase of $900 billion.
 The president could request a final increase of $1.2 trillion on the failure of Super
Committee to legislate cuts of 1.2 trillion, which would trigger end of bush era tax cuts,
sequestration automatically.
As the Lame Duck Session began in November 2012, it had the responsibility to complete
actions on a large number of outstanding legislative actions. However, by far the most important
is what to do to avert the so called ―fiscal cliff‖.
Subsequently, several rounds of fiscal provisions were scheduled in the end of 2012 where
several issues which bothered the country‘s economy were put into limelight. Some of the
questions pondered upon were:
 Should the tax code be used to heavily promote income distribution or aim instead to
raise revenue in the least distortive manner possible?
 How large should federal spending be?
 Should PPACA(Private Protection and Affordable Care Act) be modified or repealed?
 Should there be a federal estate tax and if so, at what level?
 Should the payroll tax be reduced and if so, how should we fund Social Security and
Medicare?
 What should Social Security, Medicare, and Medicaid look like as the population ages?

We know that fiscal policies play an important role in stabilizing the economy. It can stimulate
growth and bring an upraise in the GDP. When economic conditions improve fiscal policy can be
tightened to support the public finances and prevent the economy from overheating. But in the
current scenario, the US is left with no other option but ‗fiscal cliff‘. The bill had to be passed by
the Senate and signed by the President.
On December 31, 2012, a large swath of the federal income tax code is scheduled to expire,
among the expiring provisions are the 2001 and 2003 tax cuts enacted under President Bush, a
compromise on the estate tax, a ―patch‖ in the Alternative Minimum Tax (AMT) reducing its
impact, the temporary 2 percent payroll tax holiday, increased business expensing, and the
extenders package of miscellaneous tax deductions. On January 2, 2013, President Obama
signed into law the American Taxpayer Relief Act of 2012 (ATRA), which addressed many of
these tax and spending policies.
On January 1, 2013, five taxes enacted as part of the Patient Protection and Affordable Care Act
(PPACA)—popularly referred to as ‗ObamaCare‘ will take effect, along with Sequester
spending reductions of $109 billion due to the failure of the ―Super Committee‖ to reach
consensus on budget reductions. However, the latter is put on hold for its expected turmoil in the
economy. Taken together this ―Taxmageddon‖ could potentially reduce economic output by
hundreds of billions of dollars.
Congress and the President will have little time to rest after the new year as in the late
February, the U.S. government will hit the debt ceiling, exhausting its ability to borrow to
finance ongoing spending. The broad goal behind the fiscal cliff is to make the US debt level
more reasonable. Right now, the country‘s debt-to-GDP ratio is 70%, the highest level in more
than 70 years. By contrast, that‘s slightly lower than Germany‘s debt/GDP ratio of 81%, and
more than double Greece‘s ratio of 163%. Economists have generally concluded that when a
country reaches a debt/GDP ratio of more than 90% or 100%, economic growth is constrained.
It would be bitter medicine. A recession would begin in the first half of 2013, reducing U.S.
economic growth by about 0.5%. Unemployment would increase. The jobless rate would rise to
9.1% by Dec. 2013 from 7.9% today.
With these predictions, US government had to take a strong stand to restrict further degradation
of the economy. Through its fiscal cliff deal it would try reduce deficit through 2013. The
question here is how did US proceed to the cliff? The timeline in the next page describes the
march toward the Fiscal cliff.

Figure 1: TIMELEINE
PASSING OF THE FISCAL BILL
Three hours before the midnight deadline on January 1, the Senate agreed to a deal to avert the
fiscal cliff. The Senate version passed two hours after the deadline, and the House of
Representatives approved the deal 21 hours later. Since the final details weren't hashed out until
after the beginning of the New Year, but the changes incorporated in the deal will be backdated
to January 1, 2013 with retrospective effect.

THE FISCAL DEAL - BEGINNING OF A NEW ERA
THE END OF LAST YEAR PAYROLL TAX CUTS FROM MARCH 2013
Payroll taxes to rise to 6.2 percent from 4.2 percent on workers‘ earning below $110,100 p.a. of
income, this would mean that taxpayers may see a roughly $83 monthly cut in take-home pay
striking from March as excess social security tax. This affects an estimated 87 percent of the
American population, for millions of working people struggling to make ends meet a 2 percent
cut in payroll is a serious hardship. If you're taking home less money, you can either take down
your savings level or cut discretionary consumption. Given the choice, most people will
ultimately reduce their spending on items they want but don't need. It will cost about $120 billion
in revenue which is about 0.8% of GDP. Meanwhile many wealthy investors will continue
reaping the payroll tax cuts above $110,100 of income which includes the most highly paid white
collar and skilled workers as well as managers and executives.
EXAMPLE: Mr. X makes $4 million dollars a year and Mr. Y makes $40,000 a year. The person
making $4 million Mr. X is only paying payroll taxes on 2.7 percent of his income and Mr. Y on
every dollar of his income. Now who‟s not getting a fair shake!
Laffer‘s curve – A Supply Side Analysis
According to Laffer's theory, changes in tax rates affect government revenues in two ways.
1) Arithmetic effect: It‘s an immediate effect. Every dollar in tax cuts translates directly
to one less dollar in government revenue.
2) Economic effect: The other effect is longer-term. This works in the opposite direction.
Lower tax rates put more money into the hands of taxpayers, who then spend it. This
creates more business activity to meet consumer demand. Next, companies hire more
workers, who spend their additional income. This boost to economic growth generates a
larger tax base, which eventually makes up for the initial revenue lost from the tax cut.

Figure 1: LAFFER CURVE
The figure above shows that increasing taxes will immediately boost US government revenue in
the beginning and does a good job of increasing total revenue, as shown by the flatness of the
curve which is increasing at an increasing rate initially and then increasing at a decreasing rate
till the non-shaded area. But as the government will keep increasing taxes beyond the non-
shaded area, the curve starts bending backward. As raising taxes after a limit inhibits
consumption and investment that becomes a burden on economic growth. The section is shaded
is the "Prohibitive Range." Long-term decline in the tax base more than offsets the immediate
increase in tax revenue.
Tax increases have a multiplier effect of anywhere from 1 time to 3 times in US as stated by
Obama's former head of the council of economic advisors. Let's use 2 times as an average for our
discussion. Various studies show that expenditure cuts takes about 1 year to be absorbed into the
economy and tax cuts take a little longer to have their full effect because it first has an impact on
the consumption and then on the total output. We saw that the US economy grew around 2% in
2012. If there is a 2 times multiple on tax increase, then the negative stimulus will be worth
anywhere to 0.5% in 2013 which is most of the growth we had in the US this last year and
evidently US would face a very low growth rate around 1.5% in the following period. Also if we
do nothing about the deficit, in three years US is over 100% as per the estimates.
EXAMPLE: Let's run a thought experiment on a country with a large debt of say 80% of debt-to-
GDP and a deficit of 8%, with interest cost of about 2%. Revenues are 16% from taxes, and
expenses are 24%. First, this means that the debt carries an interest rate cost of about 1.6% of
GDP, or around 10% of revenues. If the debt rises to 100% of GDP, then the interest costs will

rise to about 2% of GDP, or about 12.5% of revenues. This will force spending cuts or tax
increases as most of the revenue will be utilized in paying interest on large debt, provided the
deficit is not allowed to rise. If we consider the other case and the govt. cuts spending (also
known as austerity), then we will see a negative tax multiplier of about 1.5% of GDP over that
time period. That means it will be harder to grow our way out of the problem, especially if the
economy is growing at less than 2% annually. Debt at the levels we are talking about makes it
much harder to grow yourself out of debt.
IMPLICATION: So conclusively, on the basis of Laffer curve analysis, it‟s a better option to take
rising debt in control now; but not by ending payroll tax cut benefit of the lower income group
rather making spending cuts without shortchanging items like education, job training, research
and technology, which are critical to the nation's prosperity. What‟s important is to identify
responsible ways to tackle wasteful spending than waiting and blowing up the country‟s debt
which has the implication of losing further debt flexibility, has a growth constrain and plummets
credit rating.
THE END AND RENEWAL OF CERTAIN TAX BREAKS FOR BUSINESSES
The law maintains that all those having current levels of income above $400,000 (singles) and
$450,000 (couples) would permanently incur increased tax rates on income above that to 39.6%
from 35%. Most of the media attention has been focused on the restoration of Clinton-era income
tax rates. The plan has also raised tax rates on capital gains and dividends from 15% to 20%
income over $400,000 (singles) and $450,000 (couples). It also reinstates provisions that phase
out personal exemptions and deductions for incomes over $250,000 (singles) and $300,000
(couples). With the end of this tax break it‘s the rich section that‘s being most hurtful. That‘s the
reason for extreme media interest in this provision as of course that well-heeled network
anchormen and media pundits are in this bracket along with the bulk of the Washington political
establishment and the top echelons of Wall Street.
A larger handout to the wealthy, even though limited to a much smaller group, is the limitation
on the estate tax, which is set at 40% on estates from 35% over $5 million. With the expiration
of the Bush tax cuts on December 31 2012, that rate should have snapped back to 55%. In other
words, the capping of the estate tax is a bonanza for extremely wealthy families seeking to pass
their holdings on as unearned income for a parasitic next generation.
IMPLICATION: Some more tax increment in the estate tax and other avenues that included
corporate jet owners, hedge fund managers and oil companies can be justified but Republicans
resisted. These proposals could rise as much as $64 billion over 10 years would do little to dent
the $1.5 trillion annual deficit. Deficit can't be reduced to the levels that it needs to be reduced
without having some revenues in the mix. The Republican leadership in Congress should

hopefully realise soon and come to the conclusion that they need to make the right decisions for
the country, which everybody else has been willing to move off their maximalist position and they
need to do the same.
If we see the other side of the deal we see tucked into the fiscal cliff, tax package approved by
Congress is billions of dollars in tax breaks that should make 2013 a lot happier for businesses of
many stripes. More than 50 temporary tax breaks were renewed through 2013, saving businesses
and individuals of about $76 billion, attracting intense lobbying and campaign donations from
businesses and trade groups that say the tax breaks help them prosper and create jobs. The
package passed by Congress this week and signed by President Barack Obama renews the tax
breaks retroactively, so taxpayers can claim them on both their 2012 and 2013 tax returns.
Among the provisions of favorable tax breaks are:
• A tax credit for Research and Development (Cost: $14.3 billion): Benefiting a wide
range of industries, including manufacturers, pharmaceutical companies and high tech
companies in competing against foreign competition.
• An exemption to Financial Institutions (Cost: $11.2 billion): It will allow banks,
insurance companies and other financial firms to shield foreign profits from being taxed
by the U.S.
• A tax break that allows profitable Companies to write off large capital expenditures
immediately (Cost: $5 billion ): Giving some companies huge tax shelters in form of
bonus depreciation and benefits automakers, utilities and heavy equipment makers.
• A tax credit for the production of Renewable Energy (Cost: $12.2 billion): Allows tax
credit for wind, solar and other renewable energy. There's also a provision to continue
subsidizing coal produced on Indian lands at about $2 per ton.
• A provision that allows Restaurants, Retail stores and Motorsport race tracks to
quickly write off the cost of improvements. (Cost: $4.5 billion)
• Increased tax rebates to Puerto Rico and the Virgin Islands (Cost: $222 million): The
U.S. imposes a $13.50 per proof-gallon tax on imported rum, and sends most of the
proceeds to the two U.S. territories to support their industries.
• Tax credit for expenses related to Railroad Track maintenance (Cost $331 million): A
50 % tax credit for repair and railroad maintenance work otherwise which would which
would in turn fracture the national shipping network.
• Enhanced deductions for Companies that donate food to the needy, books to public
schools or computers to public libraries (Cost: $314 million).

• A tax break for TV and Movie Productions (Cost: $248 million): to more quickly write
off expenses. Sexually explicit productions are ineligible.
Figure 3: PROPORTIONATE TAXES
As we can see, the poorer you are, the more state and local taxes bite your income. If you see the
top 1% income group, as you get richer those taxes recede and you‘re mainly getting hit by
federal taxes. So when you omit state and local taxes from your analysis, you‘re omitting the
taxes that hit lower-income taxpayers hardest. Here is another graph that depicts total tax burden
by various income groups. We‘ll see the rich aren‘t paying much more, as a percentage of their
incomes as compared to the middle class.

Figure 4: TOTAL TAXES
IMPLICATION: Congress decided not to spare most people from a hike in Social Security
payroll taxes. But they did find room for billions in special tax breaks for rum makers, racetrack
owners, railroads and Hollywood studios. We have people calling for fairness, but they want to
protect the wealthy or their supporters and that's on both sides of the aisle i.e. Democrats and
Republicans. Equality itself calls for unequal laws for unequal people. Which is why, if we want
to understand who‟s paying what in taxes, we don‟t want to just look at federal income taxes, or
federal payroll taxes, or state sales taxes rather we‟ll look at total taxes. So here are total taxes
which include corporate taxes, income taxes, payroll taxes and state sales taxes broken into
federal and state and local burdens.
SHIFTS IN THE ALTERNATIVE MINIMUM TAX EXEMPTION SLAB
The AMT was introduced in 1969 with the motive to prevent excessive tax sheltering by high-
income taxpayers that includes individuals, corporations, trusts and estates.
Thus AMT is an alternate way of calculating income tax that dictates how much someone with a
specified level of income has to pay the IRS. For instance, if a taxpayer is already paying the
required amount, he or she does not have to pay the AMT. But if the amount of money being

paid to the IRS is below the income tax owed to the IRS specified under the normal tax code, the
taxpayer is required to pay the AMT. In simple words, if your income exceeds the AMT
exemption, you must calculate both regular income tax and the AMT and pay the larger
amount.
To keep the tax trained on the wealthy, taxpayers are allowed an AMT exemption, which
decades ago was set at $45,000; high enough to miss the middle class. But this level was not
indexed to inflation, so as median incomes grew in the ensuing years, the threshold hit more and
more ordinary households and was threatening to hit more each year. Over the years and because
of inflation, incomes levels have grown to include more and more Americans. AMT is now
indexed to inflation. That means the income threshold for being subject to the AMT will rise
automatically each year. If you don‘t pay it this year, you won‘t pay it next year or any year
thereafter at least not without an income boost that outstrips inflation.
The AMT rates are 26% on the first $175000 and 28% on the rest. The AMT calculation
removes a number of tax deductions; including ―Schedule A‖ itemized deductions for state
income taxes, property tax, and limits others notably medical and dental expenses and home
mortgage interest deductions. It also removes other tax benefits including personal exemptions.
As with regular Federal income tax, rates and exemptions vary by filing status.
STATUS SINGLE COUPLE
TAX RATE-Low 26% 26%
TAX RATE-High 28% 28%
HIGH RATE STARTS $1,75,000 $1,75,000
EXEMPTION IN 2009-2010 $46,700 $70950
EXEMPTION IN 2010-2011 $47450 $72450
EXEMPTION IN 2012 $48450 $74450
EXEMPTION IN 2013 $33750 $45000
Table 1: AMT SLAB
Till few months back, 4 million taxpayers paid AMT for 2011. Without the patch for this year,
however, the exemption reverted to $33,750 for individuals and $45,000 for married filing
jointly, the IRS estimates, will cause 28 million more taxpayers to be subject to the tax, giving
them a much larger tax liability than they had anticipated.

EXAMPLE: Take the case of Mr. and Mrs. X. In 2011, their adjusted gross income was $50000.
It was below the AMT exemption i.e. $74450, the AMT didn‟t apply to them. In 2012 their
adjusted gross income is again $50000 which is above the AMT exemption i.e. $45000 and now
they must calculate their both regular income tax and AMT and hence pay the larger amount
Figure 5: COMPARING AMT CURVES
IMPLICATION: AMT exemption hasn‟t been indexed to the rate of inflation in order to regulate
only large tax payers‟ manipulations and bookkeeping tricks till now. But in the mid of recent
modifications, the “fix” has been made permanent to $33750 (earlier $48450) for singles and
$45000 (earlier $74450) for married which is subject to inflation. Many upper-middle income
taxpayers are also included in the AMT slab with this change. As the graph shows, while many
were exempted from AMT till 2011-2012 and 2012-2013, 28 million taxpayers are now subject to
AMT which is a cause of distress. The best part is its indexation to inflation which has removed a
significant source of uncertainty about taxation and prevented large number of taxpayers onto
AMT in future years.
0
10000
20000
30000
40000
50000
60000
33750 45000 48450 74450 175000 200000
Single (Earlier)
Single (Now)
Couple (Earlier)
Couple (Now)

SEQUESTRATION
Sequestration is a process where an amount of money equal to the difference between the cap in
the budget resolution and the amount actually appropriated is sequestered by the treasury and not
handed over to the agencies to which it was originally appropriated by the Congress. It is an
automatic form of spending cuts to all federal discretionary and most mandatory federal
programs. The Budget Control Act of 2011 established a ―Super Committee‖ charged with
reducing the deficit by $1.2 trillion over 10 years.
The sequestration is the result of the failure of the Joint Select Committee on deficit reduction
to propose, and Congress to enact, legislation reducing the deficit by $1.2 trillion, as required by
the BCA of 2011. A July 2012 study commissioned by the Aerospace Industries Association
found that sequestration‘s cuts to non-defense spending would reduce the U.S. GDP during FY
2012-21 by a greater amount ($77.3 billion) than cuts to defense spending ($72.1 billion).
Administrative Department of Executive Office of the President of the US strongly believes that
sequestration is a bad process and congress should and must take actions to avoid it by passing a
comprehensive and balanced deficit reduction package. Sequestration would be deeply
destructive to national security, domestic investment and core government functions.
Figure 6: SEQUESTER CUTS
0
2
4
6
8
10
12
Defence
Discretionary
Funding
Defence
mandatory
Funding
Non-Defence
discretionary
funding
Non-Defence
mandatory funding
Medicare
Sequester Cuts(%)

Under the assumptions required by the STA (Sequestration Transparency Act 2012), the
sequestration would result in a 9.4% reduction in non-exempt defense discretionary funding and
an 8.2% reduction in non-exempt non-defense discretionary funding. The sequestration would
also impose cuts of 2% to Medicare, 7.6% to other non-exempt non-defense mandatory
programs, and 10.0 percent to non-exempt defense mandatory programs.
Sequestration would have a devastating impact on important defense and nondefense programs.
While the Department of Defense would be able to shift funds to ensure war fighting and
critical military readiness capabilities were not degraded, sequestration would result in a
reduction in readiness of many non-deployed units, delays in investments in new equipment and
facilities, cutbacks in equipment repairs, declines in military research and development efforts,
and reductions in base services for military families.
CALCULATION OF TOTAL ANNUAL REDUCTION BY FUNCTIONS (in billions of dollars)
Joint Committee Saving Target 1200.0
Deduct debt service savings (18%) (216.0)
Net reductions 984.0
Divide by 9 to calculate annual
reduction
109.3
Split 50-50 between defence and
non-defence functions
54.7
Table 2: MECHANICS OF SEQUESTRATION
The Budget Control Act would evenly split the $1.2 trillion in automatic reductions over the
nine-year period between defense and nondefense spending categories. The Office of
Management and Budget (OMB) is required to determine the annual amount of spending to be
cut from defense and nondefense budgets after 18% attributable to debt service savings ($216
billion) is subtracted from the act‘s $1.2 trillion in deficit savings ($984 billion), or almost $54.7
billion from the defense and $54.7 billion from the nondefense budget functions per fiscal year
from 2013 through 2021. Within the defense and nondefense functions, the annual amount of
spending reductions must then be divided proportionally between their respective discretionary
and mandatory programs. The actual allocation is shown in the table below:

Discretionary Spending Caps Under the Budget Control Act
(budget authority in billions of current dollars)
2013 2014 2015 2016 2017 2018 2019 2020 2021
Defense Category 546 556 566 577 590 603 616 630 644
Nondefense Category 501 510 520 530 541 553 566 578 590
Total Cap 1,047 1,066 1,086 1,107 1,131 1,156 1,182 1,208 1,234
Table 3: DISCRETIONARY SPENDING CAPS
1) Non-Defense Sector:
On the non-defense side, sequestration would undermine investments vital to economic growth,
threaten the safety and security of the American Population and cause severe harm to programs
that benefit the middle-class, seniors and children. Education grants to States and local school
districts supporting smaller classes, afterschool programs, and children with disabilities would
suffer. The number of Federal Bureau of Investigation agents, Customs and border patrol
agents, correctional officers etc. would be slashed. The Federal Aviation Administration‘s ability
to oversee and manage the Nation‘s airspace and air traffic control would be reduced. The
Department of Agriculture’s efforts to inspect food processing plants and prevent foodborne
illnesses would be curtailed. The Environmental Protection Agency’s ability to protect the
water we drink and the air we breathe would be degraded. The National Institutes of Health
would have to halt or curtail scientific research, including needed research into cancer and
childhood diseases. The Federal Emergency Management Agency’s ability to respond to
incidents of terrorism and other catastrophic events would be undermined. And critical housing
programs and food assistance for low-income families would be cut.
Among the highlights:
 States and local communities would lose $2.7 billion in Federal funding for just three
critical education programs alone – Title I, special education State grants, and Head Start
that serve a combined 30.7 million children. Nationwide, these cuts would force 46,349
employees to either lose their jobs or rely on cash-strapped States and localities to pick
up their salaries instead.
 In health, 659,476 fewer people would be tested for HIV, 48,845 fewer women would be
screened for cancer; and 211,958 fewer children to be vaccinated.

 At a time when the unemployment rate is still above 8%, 1.6 million fewer adults,
dislocated workers and at-risk youth would receive job training, education and
employment services; and the families of 80,000 fewer children would receive child care
subsidies, making it harder for parents to find work.
Nondefense discretionary (NDD) spending already has absorbed significant reductions through
the 10-year spending caps in the Budget Control Act and other measures. By 2021, this category
of spending will account for just 2.8% of the U.S. gross domestic product, its lowest level in
more than 50 years. It defies not only reason, but also fairness and equality, to suggest that we
can erase our national debt by slashing critical priorities like education and medical research
while holding Pentagon spending harmless and expecting the wealthiest among us to sacrifice
nothing.
2) Defense Sector
Sequestration, if allowed to go into effect would alter virtually every aspect of DoD‘s planning.
It would force a uniform reduction in budget authority of roughly 10.3% across all accounts
other than military personnel. Because of the delay between budget authority and outlays, the
corresponding reduction in outlays from sequestration would be roughly 4.6% in FY 2013. The
lag between budget authority and outlays means that the full effect of sequestration on defense
contractors would not be immediate and would not appear to require large-scale layoffs in
January of 2013. Sequestration would, however, force layoffs of roughly 108,000 DoD civilian
employees soon after it takes effect. The Defense industry overall could begin planning to
reduce capacity and possibly to jettison capabilities on the assumption that DoD will not have the
funding necessary to continue certain programs in the future.
The fact that sequestration acts on budget authority rather than outlays provides some insulation
for defense companies because it allows more time for adjustment. If sequestration occurs,
defense firms will be able to continue working on contracts already awarded because
sequestration does not affect funding that has already been obligated. Sequestration will,
however affect DoD‘s ability to award new contracts and exercise options on contracts. Over
time this will result in a decline in revenues for defense firms but it will be 3-4 years before
defense companies feel the full impact of sequestration. This gives industry more time to adjust
employment levels through natural attrition and early retirements rather than forcing immediate
layoffs. The defense industry will be forced to downsize and employment in defense companies
will decline if sequestration occurs, but this downsizing will happen gradually over the months
and years that follow as outlays decline. While sequestration will not force an immediate
reduction of 10 percent of the defense contractor workforce, it will force an even larger
immediate reduction in the size of the DoD civilian workforce.

What Sequestration will not apply to the Defense sector?
While sequestration will affect nearly every part of DoD, it also important to note several things
sequestration will not do.
 No Layoffs or Furloughs of Military Personnel: Because the president has already
given notice to Congress that he will exempt military personnel accounts in the event of
sequestration, no members of the uniformed military, whether in the active or reserve
component, would be separated from the Service because of sequestration.
 No Reductions in Pay for Military Personnel: Basic pay, allowances for housing and
subsistence, retirement pay, special pays and bonuses, and many other benefits would not
be affected by sequestration because they are funded through military personnel accounts.
The one notable exception is military healthcare.
 No Immediate Program Terminations: While sequestration will reduce funding for
nearly all acquisition programs across DoD, it will not directly terminate programs. An
across-the-board reduction will force DoD to renegotiate many contracts to be able to buy
in smaller quantities since less funding will be available. This would likely cause unit
costs to rise and reduce the Department‘s purchasing power, which could cause DoD to
reconsider continuing some acquisition programs in the future, particularly if the cuts
currently mandated under the BCA for FY 2014 to FY 2021 remain in effect.
Effect on jobs:
Spending by the federal government supports (creates or maintains) jobs in three ways:
 It does so directly by paying the salaries of federal employees and by contracting with
firms in various industries to produce final products. Jobs supported in this way are
referred to as direct jobs.
 Federal government spending also supports jobs indirectly when contractors use a portion
of their federal awards to buy outputs from businesses in other industries that are
incorporated in the finished products of prime contractors. The jobs supported by the
purchases of prime contractors are referred to as indirect jobs.
 Lastly, when workers in direct jobs (e.g., federal employees and employees of
shipbuilders) and indirect jobs spend their paychecks, additional jobs are supported by
federal spending. These are referred to as induced jobs.

Most of the studies, applied employment multipliers to their estimates of reduced agency
spending under the BCA to calculate the approximate number of jobs by industry and state that
would no longer be supported by federal purchases (i.e., projected job losses).
Of the estimated 2.1 million job losses,
 746,000 were direct jobs (277,000 federal civilian jobs and 469,000 prime contractor
jobs).
 433,000 were indirect jobs at suppliers and other firms that depend on prime contractors
for business.
 959,000 were induced jobs (i.e., jobs throughout the economy supported by workers in
direct and indirect jobs spending a portion of their paychecks).
Federal government employees could face much larger direct and indirect job losses as a result
of cuts to nondefense budgets (268,000 jobs) than to the defense budget (56,000 jobs). In the
private sector, employees at professional and business services firms13 could face the largest
direct and indirect job losses (180,000) due to nondefense budget cuts and manufacturing
employees might incur the largest job losses (223,000) due to DOD budget cuts.
IMPLICATION:
1) Defence
a) Since the DOD‟s ability to award new contract is affected, there will be decline in the revenue of
the defence firms. However, this impact wouldn‟t be felt soon, as a result of which the defence
companies would get time to adjust their employment levels. There will be larger immediate
reduction in the size of DOD civilian workforce than defence contractor workforce.
b) If the cuts stay in effect for foreseeable future, defence industry must begin to reduce its capacity
which would restrict it to fund certain future programs.
However, sequestration will have no effect on the layoffs and pay of military personal (military
healthcare being an exception) and there won‟t be any immediate program termination.
2) Non Defence
a) In domestic social services, 100,000 fewer children would be enrolled in Head Start, and
20,000 Head Start employees would lose their jobs. This implies a low teacher-student ratio.
b) In health care, sequestration cuts would mean 1,000,000 fewer patients served in community
health centres and an estimated 45,000 low-income women would not receive breast and
cervical cancer screenings. There would be 2,400 fewer National Institutes of Health research
project grants awarded, and 1,600 fewer National Science Foundation research and education
grants supporting 19,300 fewer researchers, students and technical support staff.

c) In anti-poverty programs, some 900,000 participants would be dropped from the Women,
Infants and Children Supplemental Nutrition Program; 80,000 fewer low-income children
would receive child-care.
THE BEGINNING OF OBAMA HEALTH CARE LAW FROM 1 JAN 2014 (estimated date)
‗ObamaCare‘ health care plan reform requires that all Americans, purchase a private health care
plan or pay a 1% - 2.5% tax for the public health plan undertaken by the government. Americans
who cannot afford health insurance will either qualify for Medicare/Medicaid or get assistance in
the form of tax credits, tax breaks or assistance with up-front costs on the Health Insurance
Exchanges (HIX).
Medicaid is a means-tested health and medical services program for certain individuals and
families with low incomes and few resources. Medicare is a Federal health insurance program
that pays for hospital and medical care for elderly and certain disabled Americans.
The highlights of ObamaCare are:
 Establishing a new public program that would be available to those who do not have
access to an employer plan or qualify for existing government programs like Medicaid or
Medicaid. This would also be open to small employers who do not offer a private plan.
 Creating a ‗National Health Insurance Exchange‘ which would be a government-run
marketing organization that would sell insurance plans directly where customers can shop
for affordable quality health insurance. Small businesses can also use the exchange to
purchase insurance for their employees. The Health Insurance Exchanges will open in
Oct of 2013; coverage starts Jan 1st, 2014.
 An employer ―Pay or Play‖ provision that would require an employer to either provide
health insurance or contribute toward the cost of a public plan.
 Mandating that families cover all children through either a private or public health
insurance plan.
 Expanding eligibility for government programs, like Medicaid and SCHIP.
 Allow flexibility in embracing state health reform initiatives.

Figure 7: SOURCES OF INSURANCE IN US
30 million Americans who currently do not have health insurance will be covered under new
health care law. Other coverage milestones include better preventative care, women's health
services, and better care for seniors and expanded coverage of our nation‘s poorest.
The ObamaCare cost will be around $1.1 trillion over the next ten year according to an updated
CBO report. This number may seem big and is to be raised in the following manner:
Americans are allowed to deduct medical expenses to the extent the costs exceed 7.5 percent of
one‘s adjusted gross income. The new Obama Care provision will raise that threshold to 10
percent. (Revenue $15 billion)
The Americans who have Flexible Spending Accounts will face a new federally imposed
$2,500 annual cap. These pre-tax accounts currently have no federal limit; will play an
unwelcome role in everyday kitchen-table health care decisions. The cap will also affect families
with special-needs children, whose tuition can be covered using FSA funds. Special-needs tuition
can cost up to $14,000 per child per year. (Revenue $13 billion)
The new Obama Care also surtaxes the top capital gains rate to 23.8% (from 20%) and top
dividend rate to 43.6% (from 39.6%). (Revenue $123 million)
Also there will be a straight 2.3% increase on medical device makers who will raise the price
for pacemaker, prosthetic limb, stent, and operating table etc. The tax is particularly destructive
because it is levied on gross sales and even targets companies who haven‘t turned a profit yet.
(Revenue $29 billion)

IMPLICATION: The Obama campaign has argued that their plan can save $2,500 per family, or
about 8 percent of health care spending. Such savings would accrue in part to the government
and in part to the private sector. The plan should receive high marks for increasing the sharing
of health care risk through a combination of strategies that would substantially increase access
to affordable and adequate coverage for those with the highest health care needs, including
those with chronic illnesses.
But on the other hand the approach includes an employer mandate that will almost certainly
result in opposition by the business community. Also there are often small, scrappy companies
with less than 20 employees who pioneer the next generation of life-prolonging devices. In
addition to raising the cost of health care, this mammoth tax over the next ten years will not help
the country‟s jobs outlook, as the industry employs nearly 400,000 Americans. Several
companies have already responded to the looming tax by cutting research and development
budgets and laying off workers.

EFFECTS ON VARIOUS SECTIONS OF THE US ECONOMY
The United States debt-ceiling crisis was a financial crisis in 2011 that started as a debate in the
Congress about increasing the debt ceiling. The crisis ended when a complex deal was reached
and Budget Control Act was passed that raised the debt ceiling immediately and proposed
reduced increases to future government spending. The debt raising capacity of US was exhausted
and further loan could be requested by the president if required up to certain limit.
The country officially hit its debt limit, and the Treasury is undertaking extraordinary measures
to put off default. If Congress does not raise the ceiling by late February or early March 2013 by
exploiting the above clause in the budget control act, the Treasury will not be able to pay all of
its bills.
INTEREST RATES
We expect the interest rate on 10-year Treasury notes to remain very low for the next two years
and then to rise through 2018. The rates that have been projected for 2013 are lower than the
average rate in 2011 because the rate fell sharply over the course of the year amid growing
weaker economic activity in the United States. As the pace of expansion picks up we expect that
rate for 10-year Treasury notes to rise steadily.
HOUSEHOLD SECTOR
Household sector in the next few years will face weak growth in consumer spending and an
upturn in residential investment reflecting moderate growth in disposable personal income,
slowly improving household net worth and consumer confidence, and more favorable conditions
for borrowing by consumers. In particular we expect consumer spending to slow considerably
in the first half of 2013 as tax cuts expire and the automatic spending cuts specified by the Fiscal
deal. Spending on residential construction however will accelerate in 2013 as it will take
several years for the economy to absorb the large existing stock of vacant homes and bring the
construction of new housing units back to levels consistent with population growth and the
demand for replacement units.
BUSINESS SECTOR
It‘s projected that real business investment will grow by an average of about 6 percent this year
and at an even faster pace for a few years thereafter. Such growth will be concentrated in fixed
investment, meaning investment in structures, equipment, and software in contrast to inventory
investment which will probably provide less support this year that firms have rebuilt their stocks
to more-normal levels after recession in 2009. The key reason why fixed investment by

businesses is projected to grow substantially because during the recession 2009, net fixed
investment by businesses felt sharply as the costs of financing investment rose and the demand
for goods and services fell. Businesses had little need to expand their productive capacity when
so much of their existing capacity was idle and commercial real estate was vacant. Since then,
that share has risen as businesses have responded to some recovery in the demand for goods and
services and we expect that trend to continue over the next two years. When the growth of
economic activity picks up after 2013, investment will continue to grow faster than GDP as
businesses make up for the investment they postponed during the recession.
INTERNATIONAL TRADE
We expect that an increase in real net exports will make a small contribution to the growth of
real GDP this year. A primary reason for that projection is that average growth among the
nation‘s leading trading partners will probably be stronger than that in the United States over the
period, driven largely by growth in emerging economies. Another reason is that, on average over
the next two year the exchange value of the dollar will remain below what it averaged in 2009
and 2010, despite its recent increase partly in response to the banking and fiscal problems in
Europe.
JOB GROWTH RATE
The forecasts, project that wholesale implementation of tax increases and spending cuts would
sharply reduce employment. If all the policies that compose the fiscal cliff fully go into effect,
the job losses would more than erase all of the gains we have made in returning to full
employment.
If the automatic cuts to the discretionary defense budget go forward as planned, the nation would
have 400,000 fewer jobs this time next year; compared to if the defense budget remains intact.
The mandatory reductions in the nondefense discretionary budget, combined with the
restructuring of Medicare payment rates for physicians, would also reduce the number of jobs in
the United States by about 400,000 by the end of 2013.
Of course, if cutting spending reduces employment, then avoiding these cuts would result in a
greater number of jobs. If lawmakers do away with the defense and non-defense discretionary
budget cuts, and extend the Bush-era tax rates—a suite of policies known as the ―alternative
fiscal scenario‖—the country would have about 2.7 million more jobs at the end of next year.
If policymakers do not implement the alternative fiscal scenario (either in part or in whole) and
do not extend the reduction in the payroll tax and emergency unemployment benefits then it‘s
estimated that there would be 3.4 million fewer jobs in the fourth quarter of 2013, one year from
now, compared to outcomes under the alternative fiscal scenario.

CONCLUDING REMARKS
The fiscal cliff agreement is a good news to some extent although it shouldn‘t be ignored that
lawmakers had 507 days ( since August 2011 Budget Control Act) to address this problem, but
still came down to the final hours before they were able to reach a solution - an unnecessary,
self-inflicted burden on the economy and the financial market. The fiscal cliff has it positive and
negative side. The figures below describe the effect in a vivid way.
US Federal debt under different fiscal scenarios (%GDP)
Source: Congressional Budget Office
Figure 8: ALTERNATIVE SCENARIO 1
This figure shows that, according to CBO report, Fiscal cliff will definitely bring down the debt
by 2022. This is the positive aspect of it. Talking of the negative side, we see that, there is
sluggish growth experienced in the GDP and unemployment rate will sky rocket with its effect.
The figure below describes Fiscal Cliff‘s effect on these two sectors.
50
60
70
80
90
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
Fiscal Cliff
No Tightening

US economy in 2013 under fiscal assumptions
Source: Group Economics, Congressional Budget Office
Figure 9: ALTERNATIVE SCENARIO 2
What can we infer from the research?
With the hike in the payroll taxes, first and foremost impact would be on the disposable income
of the employees. Surely it‘s going to reduce and have a negative multiplier effect on the GDP of
the economy and bring it down. The economy is already at an imbalanced state with global crisis
and recession. On top of it, with the flavor of payroll tax, aggregate demand would further
plummet. It would have been a lesser burden if lesser percentage of the population would have
been targeted. Statistics show that over 87% of the American population is scratching their fate
due to the end of payroll tax cut. To intensify the situation, it is the middle class income
taxpayers who are wooed by the tax resolution of the New Year.
At this juncture, it is important to bring ‗tax breaks‘ into the limelight. While in the payroll tax,
middle class is hit hard even federal government‘s renewal of tax breaks did not do much justice
to the former. Tax on income, dividends, and capital gains, all saw an increase but estate tax did
not grow much, with a growth of 5 % points. Why this so, why is did it not snap back to 55%, is
the biggest question of the entire drama! Government gave tax exemptions to number of
lucrative sectors like wine industry, Hollywood etc. One reason to it might be their ability to
-2
0
2
4
6
8
10
12
0% Fiscal
Cliff
25% Fiscal
Cliff
50% Fiscal
Cliff
75% Fiscal
Cliff
100% Fiscal
Cliff
Unemploymen
t rate
GDP Growth
(%)

generate huge revenue. But why put so much pressure on the poor and exempt those who are
able to take the burden?
Focusing on the AMT, not much of a change is incorporated virtually. With the lowering of the
exemption, many upper middle class who didn‘t fall under AMT now have to take the messy
path of calculating both the taxes and pay the larger one of it. This has definitely increased the
work load of the taxpayers in their tax calculation but at the same time the mess is balanced with
the indexation of AMT with inflation. It has put an imaginary limit on the further inclusion of
new taxpayers into the slab.
The most important of all the clauses is the ‗Sequestration‘ which is currently on hold. Had it
been put into effect, it would have brought turmoil in the economy with not just affecting the
American population in financial terms but by shaking its‘ security and future human resource
development.
The other ‗on hold‘ clause of the deal is ObamaCare. While it‘s brighter side is that it has kept
social development and welfare in mind with compulsory insurance and other such provisions
but this government expenditure is taking its toll on the R&D projects by taxing heavily the
pharmaceuticals and related firms.
Which path could have been chosen?
While trying to give an edge to the US Fiscal Cliff Deal, we can categorize our findings into two
categories. First, the deal is a bit biased against the middle class such that the total tax burden for
both the middle and the high income groups is almost equivalent. Though the main aim of the
President was to equalize tax burden, the scenario is quite contrary to it. The lucrative sectors
could have been taxed a little more, it wasn‘t. It was rather exempted. While favourable tax
breaks could have been minimized for the wealthy and a fraction of the payroll tax collection
could have been substituted with the unfavourable tax breaks, government chose to take an
opposite route to cater intense lobbying and campaigning fund. They have used the shield of
employment generation of these sectors to supplement them with benefits.
Second, due to an end to the tax cuts and restricted spending, the country will definitely go
through a jolt of GDP turbulence and unemployment. Full implementation of the tax and
spending changes would push the US into recession in 2013 and reduce growth as much by 0.5%
this year.
The incentives to prevent the fiscal cliff from putting the US back into recession are very strong.
Even during periods of robust growth such a large and sudden change in fiscal policy would be
unwise, but with the US still struggling to recover from the financial crisis it would be a baffling
decision. Avoiding the fiscal cliff would be positive in the short term, but the US still needs

to take decisive action to put its public finances back on a sustainable track. As per the
estimates of CBO debt as a share of GDP would peak at 76% in 2014 before falling to 61% by
2022.
Alternatively, if some but not all of the current tax and spending policies are extended the
budget deficit would average 5.3% and public debt as a share of GDP would keep on rising,
reaching 93% by 2022.
To conclude, it is hard to say whether this strategy would bring glory to the economy or not, but
it‘s definitely a solution to the existing problem since in either way the economy will be shaken.
Whether the gamble will be fruitful or not depends on time but definitely it is not a fair one!

REFERENCES
i. Congressional Budget Office (CBO) reports, CBO.gov
o “Choices for Deficit Reduction”- Nov 2012
o “Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in
2013”- May 2012
o “The Budget and Economic Outlook: Fiscal Years 2012 to 2022”- Jan 2012
ii. “Between a Mountain of Debt and a Fiscal Cliff”, The Committee For a Responsible
Federal Budget, CRBF.org- July 2012
iii. Congressional Research Service, “The Fiscal Cliff and the American Tax Payer Relief Act of
2012”; Mindy R. Levit, Coordinator, Analyst in Public Finance, Margot L. Crandall-Hollick,
Analyst in Public Finance, Jim Hahn, Specialist in Health Care Financing, Jim Monke,
Specialist in Agriculture Policy, Janemarie Mulvey, Specialist in Health Care Financing,
Julie M. Whittaker, Specialist in Income Security; January 4, 2013
iv. Tax Foundation, “The Fiscal Cliff: A Primer”; Tax Foundation Staff, November 13, 2012
v. RBS Group: “The US economy- falling off a Fiscal Cliff”, July 2012
vi. “Under Threat Sequestration’s Impact on Non-defense Jobs and Services”; report by, Sen,
Tom Hankin, Chairman, Senate Appropriation Sub-Committee on Labour, Health and
Human Services and Education and Related Agencies, July 25, 2012
vii. Congressional Research Service: “Sequestration: A Review of Estimates of Potential Job
Losses”; Linda Levine, Specialist in Labor Economics, Oct.1, 2012
viii. OMB Report Pursuant to the Sequestration Transparency Act of 2012 (P.L. 112-155);
Executive Office of the President of the United States
ix. AAAS Analysis: Federal R&D and Sequestration; “Brief: Federal R&D Sequestration in the
First five years”; Matt Houristan
x. CSBA: “Analysis of the FY 2013 in Defense budget and Sequestration”; Todd Harrison;
August 2012
xi. “Capital Gains and the Fiscal Cliff Deal”, Forbes- 4th
Jan 2013
xii. “The Economic Implication of extending the Bush Tax Cuts”, Forbes- 12th
Nov 2012
xiii. “After the fiscal cliff a mountain range, Federal budget”, The New York Times
xiv. “Fiscal cliff deal has billion in business tax break”, Los Angeles Times
xv. “Congress passes payroll tax cut deal”, CNN.com
xvi. “Fiscal Cliff finally deals with AMT”, Time.com
xvii. “Fiscal cliff, Sequestration”, The National Law Review
xviii. “On Cliff’s edge”, M.K.Venu, Indian Express- 3rd
Jan 2013
xix. “U.S. Senate approves last minute deal on „fiscal cliff‖, The Hindu- 1st
Jan 2013
xx. ―Fiscal Cliff disputes remain as deadline nears‖, The Hindu- 31st
Dec 2012

xxi. “Fiscal cliff deal sours US Tax Reform outlook”, “Americans wary after fiscal cliff deal “,
The Economic Times- 8th
Jan 2013
xxii. “The Fiscal Cliff- on the edge”, The Economist- 15th
Dec 2012

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