What Is the Fiscal Cliff?

The "fiscal cliff" is a term used to describe the U.S. fiscal situation of bundle of significant tax increases and spending cuts due to take effect at the end of 2012 and early 2013. In total, the measures are set to automatically slash the federal budget deficit by $607 billion or approximately 4 percent of GDP between 2012 and 2013. The abrupt onset of such budget austerity in the midst of a still fragile economic recovery has led most economists to warn of a double-dip recession in 2013 if Washington fails to intervene in a timely fashion.

Revenue Increases

2001/2003/2010 Tax Cuts & AMT Patch. This series of legislation, often referred to collectively as the "Bush tax cuts," will expire on December 31, 2012, raising all income tax rates (top will go from 35 to 39.6 percent), as well as rates on estate and capital gains taxes. The alternative minimum tax (AMT) will also automatically apply to millions more citizens.

Payroll Tax Cut. The Social Security payroll tax holiday will expire December 31, raising the rate from 4.2 to 6.2 percent.

Affordable Care Act Taxes. Some provisions in the Obama health care legislation, including increased tax rates on high-income earners, are set to take effect in January 2013.

Spending Cuts

Budget Control Act. The automatic spending cuts or sequester legislated by the Budget Control Act of 2011 will hit January 2. Half of the scheduled annual cuts ($109 billion/year from 2013-2021) will come directly from the national defense budget, half from non-defense. However, some 70 percent of mandatory spending will be exempt.

Extended Unemployment Benefits. The eligibility to begin receiving federal unemployment benefits, last extended in February, will expire at year's end.

Medicare "Doc Fix." The rates at which Medicare pays physicians will decrease nearly 30 percent on December 31.

Debt Ceiling - The debt limit, which sets the maximum amount of outstanding federal debt the U.S. government can incur by law, is currently capped at $16.394 trillion. Treasury could hit this borrowing capacity again sometime in early 2013.

Source:  Council on Foreign Relations

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