Americans may have very little to celebrate on New Year's Day 2013. If Congress is unable or unwilling to come to a compromise on scheduled tax increases -- the largest in 40 years -- and painful automatic budget cuts, the nation's economy will be pushed over a "fiscal cliff" in 2013. Before we get into the potentially devastating effects of that cliff, let's explain what the term means and how Americans arrived on the edge of economic free fall.
Federal Reserve chief Ben Bernanke was the first to use the term fiscal cliff to describe a series of tax increases and budget cuts that are scheduled to kick in during the first weeks of 2013 [source: Montgomery]. If allowed to happen, the nation would almost surely plunge back into recession, according to the nonpartisan Congressional Budget Office [source: O'Keefe]. Another colorful term for the apocalyptic economic moment is "taxmageddon."
But why would Congress have passed legislation that would put the U.S. in such a mess? To answer that question, we have to go back to the debt ceiling crisis of 2011. Congress is the one that authorizes the U.S. Treasury to borrow money to pay for federal programs. When the Treasury reaches its borrowing limit, it asks Congress to raise the limit by a few hundred billion dollars, which Congress has done dozens of times [source: The New York Times].
In 2011, however, fiscally conservative tea party Republicans in the House of Representatives refused to pass any legislation that raised the national debt. They were also opposed to any debt-reduction plan that included tax increases. Without the ability to borrow money or raise tax revenue, the Treasury couldn't pay off its other debts, meaning the federal government was poised to default.
Despite months of feverish negotiations, the White House and Congress were deadlocked. In a last-minute fix, the two sides agreed to $2.4 trillion in budget cuts over the next 10 years. Only $900 billion of those cuts would be made immediately. The rest would begin automatically in early January 2013 unless the two sides could negotiate a better deal in the interim [source: The New York Times]. When a nonpartisan congressional "supercommittee" failed to reach a compromise, negotiations were tabled until after the 2012 presidential elections.
As of this writing, there is still no deal to avoid the automatic spending cuts scheduled for 2013. There is also no agreement on whether or not to extend the Bush-era tax cuts past the end of 2012. If no action is taken on these two fronts, there could be grave economic effects. We'll detail the damage on the next page.