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What is the Fiscal Cliff, and How Will it Affect Canadians?

Now that the presidential election is over in the United States, the question has gone from who will be the next President of the United States, to what in the world are they going to do about that fiscal cliff that is fast approaching? But while the term “fiscal cliff” has been thrown around a lot, and mostly just within the past several days, what does it really mean? And does it really spell the doom that the term “fiscal cliff” itself seems to imply? And, if the worst happens, how will Canadians be affected, if at all?

CTV’s Ottawa Bureau Chief Robert Fife explained the term as meaning, “a sharp rise in taxes and deep cuts in federal spending” that are set to take place in January of 2013, if the U.S. Congress can’t act quickly enough. But why the urgency, and what are the cuts a result of anyway?

It goes back to 2001, when the Bush administration implemented dozens of tax cuts and stimulus packages that totaled around $1.7 billion. At the time, Bush couldn’t gain the support of the majority of Congress, and so the packages were passed through with a condition – they would all end in 2011. But if that’s the case, then why hasn’t the U.S. faced this fiscal cliff before now?

When the Obama administration took over the White House, President Obama implemented legislation that extended the expiry date on these cuts and packages by two years. That new expiration date however, is up in January 2013.

Some say that the term “fiscal cliff” may be a bit severe, as it suggests that come January 1, 2013, the U.S. is going to fall off a steep and sudden drop. That won’t actually be the case, as the tax increases are set to come into effect at different times throughout the year. But that’s not to say that there won’t be harsh results felt, and rather quickly.

Is there any way out?

There is. The two parties in the States, the Democrats and the Republicans, could come together to instate at least some of the tax cuts as being permanent measures, meaning that the tax increases would never come and the cliff would never have to be faced. But getting the two parties to agree is difficult at best; and even if they do, they still need to find a way to leave the cuts in place, while still capping U.S. spending and finding a way to also save $1.2 trillion – and it all needs to be done within the next ten years.

What will happen if no agreement’s reached?

If the two parties can’t find a way to do it, it means that $600 billion worth of tax cuts will be imposed on American people, and American businesses. It also means that less federal government support will be available for just about everybody, and this could have a catastrophic effect on an American economy that’s still struggling in several areas to recover from the recession.

This worst-case scenario certainly has the International Monetary Fund concerned. In a recent report they stated,

“The IMF said that its forecast rested on two crucial policy assumptions. That European policymakers get the Euro area crisis under control and that policymakers in the United States take action to tackle the ‘fiscal cliff’ and do not allow automatic tax increases and spending cuts to take effect. Failure to act on either issue would make growth prospects far worse.”

And the outlook is indeed grim. Should the U.S. go over the cliff, it’s expected that their GDP would fall between 4 and 6 per cent; and unemployment would rise to a whopping 10 per cent, which would put 2.8 million more Americans out of work. The effects would be devastating to the country, and would most likely send it back into a recession. The question is, would Canada soon follow?

Canadian Finance Minister Jim Flaherty thinks so. He’s recently stated when speaking about the fiscal cliff,

“Were the entire fiscal cliff become reality, the effect on U.S. GDP, according to Americans themselves, would be four to five per cent which would put the U.S. economy into recession quite quickly, and the Canadian [economy] would follow shortly thereafter. We’re all concerned that it’s an immediate problem within the next 60 days that needs to be dealt with.”

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