What does the fiscal cliff really mean for me?

You would probably have had to have been living in a cave the last few weeks to have not heard the term “fiscal cliff”. And by some accounts it would seem that the Mayans missed it by a few days. The real end of the world will be coming January 1st when we go careening over that cliff.

But what is this all about? What is the fiscal cliff? Do we need to be worried about this? What is really going to happen on January 1st if Congress and the President are unable to come to an agreement? Are we really headed for another recession?

Many people are worried about these questions, and I recently saw a news story that summarized this in a logical easy to understand fashion.

What is a recession?

To answer that question we must first talk about the Gross Domestic Product or GDP.  The GDP is basically a measurement of whether our economy is growing or not. There are different ways the Gross Domestic Product is calculated but three of the major factors that contribute to it are:

  • Consumer spending
  • Government spending
  • Corporate spending

In a good year where the economy is growing GDP might be around 3% to 4%. This year it is expected to be about 1.5% to 2 %.

So how does this fiscal cliff affect this. Well, the first part of the fiscal cliff is the expiration of the Bush tax cuts. Combine this with the end of the 2% reduction in payroll taxes, and if no agreement is reached we will all be paying a little higher taxes next year. Higher taxes mean we have less money to spend and so consumer spending is likely to be impacted.

Another factor associated with the “fiscal cliff” are enforced budget cuts. As part of the agreement last year to raise the debt ceiling, Congress agreed to a number of automatic cuts in spending that are scheduled to kick in with the new year. If those cuts are put into effect, then that means less government spending which would have a negative effect on the GDP.

And lastly higher taxes and economic uncertainty combined with less consumer spending will mean less corporate spending as well.

Some economists have predicted that if there is no agreement reached and these measures go into effect it could reduce the GDP by up to 4% which would likely give us a negative GDP in 2013. The definition of a recession is two or more consecutive quarters of GDP that is less than 0, so it is possible that if no action is taken then we could slip back into a recession by the end of 2013.

What does GDP have to do with me?

So how does all that relate back to me? We all know that recessions aren’t usually good news but what do spending and taxes have to do with it?

First, more taxes mean less money in your wallet for you to spend. (If you are interested in how the tax changes might affect you, Market Watch posted a nice summary of some of the tax breaks that are affected.) Second, if people are spending less then companies don’t need to produce as much. If they aren’t producing as much then they don’t need as many workers which leads to unemployment and so on.

More of a hill than a cliff

The key is that GDP is calculated over a period of time. Certainly if no action is taken by the end of the year we will all see a difference in our paychecks come January. But it would take several months for it to cause the economy to fall into a recession. If Congress and the President were to come to an agreement in February lets say, then the overall effect on the economy might be minimal.

My point is that the imagery of a cliff implies that we go over it and hit bottom come the first of January, but that isn’t really what is likely to happen. It is much more likely to be a slow downward trend over the course of the year that could possibly mean we would be back in a recession by the end of 2013, but no one really knows. It’s more like cresting the top of a hill than falling off a cliff.

What can you do?

Regardless of whether Congress and the President avoid the current crisis, we all know that our economy isn’t great. Many have suffered from job losses or underemployment over the last 4 years and the last thing they need is talk of another recession. Debt issues with our government and those in Europe have caused concern for many, so what can you do?

Pay down your debt

First the less debt you have the more capable you are to weather the storms of life. This is one of the major problems with debt. It always adds an element of risk that all too often we don’t consider when we are looking at making a purchase. Less debt means less risk. If you aren’t debt free now, do what you can to start paying it down.

Increase savings

Build up an emergency fund if you don’t already have one. If you are debt free and have an emergency fund, make sure you are saving for retirement.

Pay off your home

One of the best ways of providing financial security is having your home paid for. There is a striking correlation between foreclosures and homes with mortgages. Plus if your home is paid for then that frees up cash to give you margin when life hands you lemons.

Remember who is in control

Don’t forget that if you are a follower of Christ, then ultimately He is our security. He is in control, not the President and not Congress. Of course we all still have free will and sometimes that causes us to make decisions that cause us to suffer, but in the end we are His children and He will hold us in His hands.

The Lord is good, a refuge in times of trouble. He cares for those who trust in him – Nahum 1:7

 

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