U.S. Fiscal Cliff 2012: Timeline and Causes

The 2012 Politics Behind the Fiscal Cliff Fiasco

Fiscal Cliff 2012
••• House Speaker John Boehner and President Obama. (Credit: Getty Images)

Negotiations to avoid the fiscal cliff dominated the news in 2012. The Republican-controlled House wanted spending cuts, while the Democrat-controlled Senate and the White House focused on tax hikes. This bitter stalemate reflected a shift in political power that occurred after the 2012 Presidential election.

The difficulty in reaching a compromise showed just how far both sides had dug into their ideology. While they tried to work things out, the uncertainty over the outcome slowed economic growth, keeping millions unemployed.

Here's a timeline to follow exactly what happened while history was being made. The key players were Speaker of the House John Boehner (R), Senate Majority Leader Harry Reid (D) and President Barack Obama (D).

Over the Cliff

During the final days of the year, Congress did not find a solution. However, this was partly because many Republicans had signed a pledge that they could not vote for tax increases. Instead, they would find it much easier to vote for a tax decrease after the Bush tax cuts had officially expired. For these political reasons, it would be easier to find an agreement if the country slipped off the cliff for a few days or even a week. This wouldn't be disastrous, as any agreement would be retroactive.

Some Taxes Would Increase, Regardless of Fiscal Cliff Resolution

Most people didn't realize that some tax increases weren't even part of the negotiations. First, even though Republicans wanted to repeal Obamacare, they knew that horse had left the barn. The didn't opposed those taxes as part of the fiscal cliff negotiations. Although they campaigned on repealing Obamacare, they realize they don't have enough political capital to make this happen. As a result, those who make more than $200,000 ($250,000 for married couples) will be hit with extra taxes. First, they will pay an additional 0.9% Medicare hospital tax on income above the limit.

Second, they will pay an additional 3.8% tax on the lessor of their investment income (dividends and capital gains) or wage income that is above the limit.

Everyone will pay 2% more in payroll taxes. That's because the 2010 Obama tax cuts, including a 2% payroll tax cut, expires by 2013.

Even if the fiscal cliff is averted, it's most likely that those receiving extended unemployment benefits will lose that additional source of income. That's because Obama has hinted he would be willing to give them up as part of a fiscal cliff plan.

House Caucus Rejected Boehner's Plan B

In late December, Boehner lost support from his own party for a Plan "B." This included a compromise to allow the Bush tax cuts to expire for incomes above $1 million. Many Republicans were worried that, if they voted for ANY tax increase, they would lose the mid-term elections in 2014. Stock market futures dropped more than 200 points on the news. Congress adjourned for the holidays, promising to find a solution before the end of the year. 

Fiscal Cliff Uncertainty Slowed Economic Growth

On December 12, JP Morgan Chase CEO Jamie Dimon said that the business community was OK with a higher tax rate IF the Federal government would cut entitlement spending. This showed that businesses were more relaxed about tax increases than many Tea Party Republicans. He went on to add that the economy would immediately leap to a 4% growth rate once the cliff was resolved. His prediction indicated just how much the uncertainty around the fiscal cliff was hurting the U.S. economy. 

Plan A - First Pass at a Solution

In early December, the two parties were pretty close in some areas. For example, no one wanted sequestration. However, Obama included some stimulus spending, such as building roads, that he surely knew wouldn't get passed. This initial proposal left room for negotiation and compromise. 

The Two Sides Weren't That Far Apart -- Or Were They?

On November 22, the leaders of the House and Senate met with President Obama, and it seemed a deal was imminent. Senate Majority Leader Harry Reid said the talks went so well that he thought it would be done before Christmas. It seemed the two sides were more than willing to compromise -- the Democrats would cut a little more than they wanted, and the Republicans would allow a little more tax increases than they wanted. 

$1 Trillion in Business Investment Waited for Resolution

President Obama said his highest priority after winning the election was to work with Congress to resolve the fiscal cliff. Goldman Sachs CEO Lloyd Blankfein said that there businesses were sitting on more than $1 trillion in cash, waiting for Washington to sort it out. Once the uncertainty about tax rates was resolved, that money would be put to work, expanding companies and creating jobs. 

Stock Prices Fell After the 2012 Election to Avoid the Cliff

After the November election, the stock market dropped. That's because stockholders began taking profits to avoid the tax rate increases on capital gains and dividends from the expiration of the Bush tax cuts and the imposition of Obamacare taxes.

Without a fiscal cliff solution, businesses continued to cut back on growth and hiring. They didn't want to expand in the face of a potential recession. Furthermore, some business owners sold their companies in 2012, to avoid capital gains tax increases in 2013.

 Slowed Economic Growth in 2012

Uncertainty about the fiscal cliff started slowing economic growth as early as May 2012. However, everyone knew that nothing would be done until after the election. The two candidates held widely different philosophies on the best way to reduce the debt. Obama favored raising taxes on the wealthy, and Romney favored reduction in non-defense spending. As the closely contested campaign raged on, business leaders waited. 

It Was Unnecessary

The greatest irony about the fiscal cliff crisis was that is was all self-imposed. True, the U.S. debt-to-GDP ratio was more than 100%, an unsustainable level. But for an economy as strong as the U.S., it wasn't an immediate threat. In fact, investors were more than happy to keep buying U.S. debt, keeping interest rates at 200-year lows.

No, the debt crisis was created by a Congress that didn't understand economics. In 2012, the U.S. was barely in the expansion phase of the business cycle. That wasn't the time to worry about national debt. Instead, the best time to raise taxes OR cut spending is toward the end of the expansion phase, to prevent a bubble. If the Republicans had waited a year, and let the economy fully recover, they could have been heroes -- and economic experts to boot. 

As 2012 wound down, it looked increasingly like a solution would not be found. Even if the tax hikes and spending cuts were enacted, there was still time for the newly elected officials to negotiate a solution in January. It could be retroactive to January 1, avoiding the $600 billion impact on GDP.