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The fiscal cliff may look more like a fiscal slope

June 12, 2012: 5:00 AM ET

Economists and investors have warned of an impending U.S. financial crisis at the end of this year, but others think the fears are dangerously misguided.

FORTUNE – While Europe deals with its own debt woes, fears about a looming U.S. fiscal crisis are brewing.

Last week, Federal Reserve Chairman Ben Bernanke sounded another warning to Congress about the so-called "fiscal cliff"— a series of tax hikes and spending cuts set to kick in Jan. 1, as part of a deal struck last summer to raise the federal debt ceiling. If Congress fails to take action before the end of this year, economists and analysts widely think the U.S. economy could slip into another recession.

Needless to say, Bernanke isn't the only one sounding the alarms. America's top executives, including JPMorgan (JPM) CEO Jamie Dimon, Laurence Fink of Blackrock (BLK) and Terry Lundgren of Macy's (M), have reportedly urged lawmakers to come up with a long-term deficit reduction plan before the end of the year.

But what exactly is a "fiscal cliff?" It's a question worth asking, given that fear and uncertainty certainly move markets. While another recession would obviously be painful for the U.S. and the rest of the world, could the fiscal cliff hawks be blaring their sirens a little too loudly?

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Some think so. Chad Stone, chief economist at the non-partisan Center on Budget and Policy Priorities, says the fears are misplaced. In a paper released last week, he wrote that the economy won't immediately fall over a cliff and plunge into another Great Recession come January 1. Rather than rush negotiations and end up with potentially very bad policy, policymakers still have some (although limited) time to come up with a solid plan and therefore avoid another downturn.

To be sure, Stone doesn't doubt the U.S. will slip into recession if lawmakers drag their feet for too long. The slated policy changes include an end to the temporary tax cuts enacted during the George W. Bush administration, as well as an end to the temporary Obama administration payroll tax reductions. If the slated changes take effect, the economy could contract by 1.3% during the first half of 2013 and grow by 2.3% during the second half, according to the Congressional Budget Office.

That's scary stuff. However, it will take some time before the economy feels the weight of those changes. Stone offers a few examples, starting with the tax cuts: It's true that households might feel a pinch from an increase in taxes withheld from their weekly or monthly checks, "but taxpayers newly falling within the reach of the [Alternative Minimum Tax] in 2012 will not actually pay those higher taxes until they file their returns in subsequent months," he writes.

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So while the implications of a fiscal cliff are very real, it's more like a "fiscal slope," he adds. Stone's bigger point is that good policymaking takes time. If lawmakers go past the fiscal cliff by a few weeks or a month, the economy would be okay.

But that itself is still a relatively short window. Given the host of economic uncertainties surrounding growth in Europe and China and the fact that the U.S. debt ceiling comes due in February, it's easy to see why the breathing period that Stone describes may not be enough to ease investors' worries. Recall the markets' reaction last August following the rush deal struck over the federal debt ceiling. Wall Street signaled that the deal did little to calm worries about the economy when the Standard & Poor's 500 and the Dow Jones Industrial Average saw their longest losing streaks in nearly two years.

Technically, the fiscal cliff may not sound as bad as most think. But these are incredibly uncertain times, and the market looks to be less and less forgiving.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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