Q&A with Dr. Mike Gombola: Understanding the Fiscal Cliff

Dr. Mike Gombola, professor of finance at the LeBow College of Business, provided DrexelNow with some insight into the looming tax increases and spending cuts that will begin January 1, 2013, unless an agreement is reached among Congress. Dubbed the “fiscal cliff,” this event has Washington in an uproar as both political parties must cooperate and make concessions in order to avoid possible fiscal disaster.  

Why was the fiscal cliff deadline put into place?

There was a budget duel about a year and a half ago that required the President and Congress to get together and fix some of the country’s fiscal problems or there’d be disastrous consequences. The fiscal cliff in and of itself is a combination of tax increases and spending cuts that we can’t afford to have. They must agree to a solid deal by January 2013 or a bunch of bad things will happen that neither political party wants. It’s basically a self-imposed penalty for not fixing the fiscal problems.

What will happen if we go over the fiscal cliff?

It’s bad, but it’s not horrible. There’s going to be an elimination of the Bush tax cuts and the 2 percent cut in payroll taxes, the AMT (Alternative Minimum Tax) patch and a whole bunch of defense spending cuts—about $150 billion. If this happens, it’ll probably mean that consumers have less money to spend because they are paying higher taxes, so retail spending will drop. There will also be big layoffs at defense contractors.

The bigger problem is the fiscal problem, and even going off the cliff doesn’t solve that. The general fiscal problem is that we spend too much money and don’t bring enough in. Think about a family who spends 40 percent more than their income. How long can that be sustained? That’s us. You can sustain a deficit of 3 percent GDP almost indefinitely because GDP will grow about 3 percent on average. But you can’t sustain a 10 percent deficit or it swallows you up. The real problem is we spend—and borrow—too much money.

If you combine the tax increases and spending cuts [the consequences of going over the fiscal cliff], we still have an enormous deficit. It has been running about $1.1 trillion a year. The fiscal cliff tax increases and spending cuts are less than half of that, so we’re still left [with] a deficit of half a trillion dollars, which is still huge.

Do governments and businesses take extreme measures like this often?

I have never seen it before, but this is an unprecedented fiscal problem. Personally, I’m a lot more worried about the fiscal problem we have than the immediate fiscal cliff, but we tend to focus on things that are immediate rather than things down the road.