'Fiscal cliff' 101: 5 basic questions answered

President Obama and congressional leaders are working furiously to stop the United States from going over the “fiscal cliff,” a combination of higher taxes and lower spending set to take effect Jan. 1, 2013. What is the fiscal cliff? Where did it come from? And will it get solved before sending the US into a recession? Here are five steps to understanding the fiscal cliff.

1. What’s in the fiscal cliff?

Jacquelyn Martin/AP
Senate minority leader Mitch McConnell (R) of Kentucky (r.), accompanied by House minority leader Nancy Pelosi (D) of California (l.), and House Speaker John Boehner (R) of Ohio, speaks to reporters outside the White House in Washington on Nov. 16 following a meeting with President Obama to discuss the 'fiscal cliff.'

The fiscal cliff adds up to more than $600 billion in higher taxes and lower spending in 2013. Of that total, taxes make up about two-thirds of the hit with lower spending making up a third.

The biggest chunk comes from the expiration of all the Bush tax cuts from 2001 and 2003 (which Mr. Obama and Congress extended in 2010) and Congress’s failure to patch the AMT, or alternative minimum tax, in order to adjust it for inflation. Together, those issues would raise $221 billion in new tax revenue in 2013.

On the spending side, the big-ticket item is known as the sequester. The sequester means across-the-board reductions to nearly all government programs and services (although military personnel and children’s health care, for example, are exempt). The $109 billion in reductions are divvied up between defense ($55 billion) and nondefense ($45 billion), with the balance coming from reducing the rates at which Medicare pays physicians.

Due to a variety of budgetary factors, the Congressional Budget Office (CBO) estimates that this hit will only amount to $65 billion in the first year, with the balance following in later years.

Other key items include:

  •  $95 billion in higher taxes from the expiration of President Obama’s payroll tax cut from 2010, which lowered the Social Security payroll tax by 2 percentage points for two years.
  •  $65 billion in taxes from so-called “tax extenders,” a passel of provisions that Congress routinely extends for (mostly) business interests.
  •  $26 billion in lower spending from the end of extended unemployment benefits.
  •  $18 billion in new taxes from Obama’s health-care law.
  •  $11 billion in lower payments to Medicare providers stemming from Congress’s failure to pass what’s known as the “Doc Fix,” a patch that covers shortfalls federal Medicare payments.
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