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(Kitco News) - The so-called “fiscal cliff” has occupied headlines with increased regularity, with only a brief explanation of what’s all involved.

Kitco News explains the basics of the “fiscal cliff” and why it has everyone worried.
What is it?

The fiscal cliff is a package of spending cuts and tax hikes that will come into effect on Jan. 2, the first business day of 2013, if President Barack Obama and Congress cannot agree to an alternative measure to cut the deficit. The New York Times said in the fiscal year 2013 alone, the package of tax increases and across-the-board spending cuts will be more than $500 billion. In all $1 trillion in spending is set to be reduced over 10 years, with another $1.2 trillion in savings to be identified by January. If the second set of savings can’t be agreed to, then these automatic cuts kick in.

How did it get its name?

It was coined by Federal Reserve Chairman Ben Bernanke in February in an effort to warn about what would happen if the spending cuts and tax hikes would occur.

Why is it happening now?

This dates back to August 2011 when Obama and the Congress fought over raising the debt ceiling, which is the amount of money the U.S. can borrow. Normally Congress raises the ceiling without much fanfare. In 2011, Tea Party-backed Republicans said they would not agree to raise the debt ceiling unless the U.S. started to look at its spending. A bitter fight ensued – gold prices rose to their all-time high of $1,921 an ounce that September  – and the U.S. came close to not paying its obligation. The deal that was struck allowed the debt ceiling to rise in exchange for a plan to cut the national deficit. If there was no plan, then sequestration would kick in.

What’s sequestration?

Back in 1985, the Gramm-Rudman-Hollings Deficit Reduction Act created a congressional procedure known as sequestration. Under sequestration, if the deficit exceeded a set of fixed deficit targets, automatic spending cuts kicked in. Theoretically, cuts should be across-the-board and equal, but Congress often exempts certain programs, which means other programs are hurt. However, sequestration rarely occurs since Congress raises the spending caps.

What taxes will rise?

Taxes will rise on about everyone and every business. The most notable tax cuts that will expire on Dec. 31 include all of the Bush-era tax cuts that were expanded during Obama’s first year in office, and the two-percentage-point cut in payroll taxes that funds Social Security. Something called the Alternative Minimum Tax, which is an income tax imposed at a roughly flat rate above a certain level, is also set to rise.

What are the spending cuts and where are they occurring?

Pretty much everywhere. Money for the majority of federal programs, both military and domestic, will be cut. The New York Times said more than $500 billion roughly equals about 3% to 4% of gross domestic product. Given that the last reading of GDP for the third quarter was 2.7%, it could push the U.S. into a recession. The Congressional Budget Office said a short recession would occur if the tax hikes and spending cuts occurred.

Crunching the numbers further, The Guardian said $109 billion will come out of the federal budget every year for the next 10 years. Half comes, or about $54.7 billion, comes from defense spending, half will come from domestic programs, including Medicare, the federal health care program for the elderly, which will see an $11 billion cut. There are also concerns that federal unemployment benefits won’t be extended.

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By Debbie Carlson of Kitco News; dcarlson@kitco.com

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