4 things to know about the 'fiscal cliff'

An explainer for the term being used to describe the perfect storm of calamities that experts say has the potential to throw America's economy back into recession

What is it?

It's the term being used to describe a possible perfect storm of economic calamities that the United States is currently on track to hit in the near future. A series of tax cuts – some of which date back as far as the George W. Bush presidency – are set to expire.

Most of the so-called "Bush tax cuts" were targeted at the ultra-rich, but a payroll tax cut is also set to end, which will mean a two per cent tax hike for all salaried workers. Other tax breaks on things like the alternative minimum tax and the unemployment extension kick in, just as the first round of taxes related to President Obama's health care plan become law.

Investors are watching carefully to see how America is going to solve its looming fiscal cliff problem. (Lisi Niesner/Reuters)

Add it all up and it's a bigger bill than American taxpayers are used to. That's all happening against the backdrop of a bunch of spending cutbacks coming into effect that the administration agreed to during America's acrimonious debate over raising the debt ceiling. All in all, it's been estimated that as many as 1,000 government programs are on the chopping block.

The increase in tax revenues might be good for Uncle Sam's finances, but the end of those tax breaks is going to mean less money in real people's pockets.

If U.S. consumers start spending less just as government spending also dries up, the fear is that could be enough to push the world's largest economy over the edge and back into recession – hence, going over the 'fiscal cliff.'

"The Fiscal Cliff is – simply put – the biggest tax increase [and] spending cut in history," money manager Leon LaBrecque of investment firm LJPR said recently. "It's a colossal mess."

When will it happen?

Unless something changes, January 1st. That's the date when laws that are already on the books dictate all the already mandated tax changes and spending cutbacks go into effect.

There's also America's debt ceiling factoring into the equation. It's hard to tell exactly when it will happen, but experts agree that the U.S. government is going to come near its recently-raised debt ceiling soon, and is going to need lawmakers to come together to agree to raise it again in order to avoid defaulting.

The prospect of a new round of spending concessions coming out of those negotiations has the potential to make a bad situation even worse. Again, the timing is tricky to predict, but there's broad agreement that America is going to be up against its debt ceiling at some point between the end of 2012 and early 2013.

What's being done to avoid it?

As the chart above shows, web searches for the term "fiscal cliff" have skyrocketed, a clear suggestion that it's entered the public consciousness.

But beyond a lot of talk, not a lot is actually being done about it yet. With a lame-duck Congress where members who were voted out in the recent election are still in office and newly-elected members who have to deal with the decisions have yet to move in, there's unlikely to be a breakthrough any time soon.

Some people are optimistic that Congress can hammer out a deal between now and the end of the year. As investment guru Dennis Gartman told CBC News in an interview recently, lame-duck Congresses are sometimes very effective because they cut through the partisanship. "They're either utterly useless or a lot gets done," he said.

About three-quarters of Canada's exporters depend on the U.S. market. (Mark Blinch/Reuters)

The good news is that all sides agree something must be done. But the main problem is that none of the obvious outcomes are particularly appealing to anyone. Maintaining the status quo might help the U.S. government slay its deficit, but in the real economy, growth is likely to come to a standstill.

Moving to cancel some or all of the tax measures or spending cuts might be possible, but experts say that would just be kicking the can down the road, to be dealt with later.

How would Canada be affected?

As the old saying goes, "when America sneezes, the rest of the world catches a cold" and Canada is especially vulnerable to any shocks from its southern neighbour.

Some 76 per cent of Canada's exports go south of the border, so manufacturers and exporters of all stripes would acutely feel any sort of slowdown in demand from the U.S. economy.

As TD Bank economist Craig Alexander told CBC News recently: "It would wipe out economic growth in Canada."

The Congressional Budget Office estimates the combination of tax hikes and spending cuts will be enough to shave $560 billion U.S. from America's deficit. Ordinarily that might be construed as a good thing, but the CBO also says that would be enough to shave four percentage points off America's GDP.

Given that America's economy is currently expanding at an annual rate of about two per cent, that means the fiscal cliff would be enough to turn small growth into at least a mild recession. Canada can't help but be dragged down by that sort of a slowdown.

As the 'cliff' analogy suggests, the downside to going over the edge is hard to tell at first. But as time goes on, it gets harder to stop the negative momentum once it's started. Making the impact down the line guaranteed to devastate.