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More fiscal cliff analysis

A bit more in-depth analysis when thinking about the fiscal cliff. Created by Sal Khan.

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  • blobby green style avatar for user Jim Maher
    Do I understand this presentation correctly?

    Recap:
    In summary (and ignoring the endless debates over the details of specific spending cuts and revenue increases in the various scenarios), the GROSS results of current budget options are as follows.

    Republican proposals result in:
    • LESS deficit spending than today
    • More money available to middle-class
    • More money available to wealthy
    • LESS money available for government spending

    Democratic proposals result in:
    • LESS deficit spending than today
    • More money available to middle-class
    • LESS money available to wealthy
    • SAME money available for government spending

    Fiscal cliff consequences result in:
    • MUCH LESS deficit spending than today
    • LESS money available to middle-class
    • LESS money available to wealthy
    • LESS money available for government spending

    The political objection to the Fiscal Cliff scenario is the probable economic impact of the MUCH less deficit spending. Economists and politicians suggest more economic spending, somehow, to maintain the fragile recovery. The presentation suggests that such spending could be achieved by the middle-class OR the government, but the government would do it much less efficiently. (Supposedly, the wealthy would NOT spend - but simply add the money to an already over-capitalized investment system.)
    (120 votes)
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    • spunky sam blue style avatar for user Sal Khan
      From the author:Yes, this is a good summary. There are no absolutes here, but the general argument is that being overly aggressive in deficit reduction might throw the economy into another recession. Both Democrats and Republicans believe that keeping taxes low on the middle-class is key here. Democrats believe that the government also needs to do more investment (and by doing so will help accelerate the economy more than extended tax cuts for the wealthy). Republicans believe that the money should be in the private sector where it can be invested.

      Given the low interest rate environment, generally anemic utilization of existing capacity, and high corporate cash balances, it's not clear that more cash for the wealthy would result in significant investment (without things like utilization picking up). At the same time, the Government has a role in investing in things like basic R&D and improving infrastructure, but one should have a healthy skepticism of any government program (because it can be inefficient and easier to start than to stop).
      (127 votes)
  • blobby green style avatar for user Winton Schoneman
    In your presentation, you represent $1 going to three distinct groups...Gov, MC and Affluent. With historically low interest rates, wouldn't the affluent be more likely to invest that dollar than to save the dollar seeking a larger return?
    (15 votes)
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    • spunky sam blue style avatar for user Sal Khan
      From the author:We have historically low interest rates so "cost of capital" does not seem to be a barrier to investment. Put another way, anyone with access to capital markets (and people who make over $250k/year tend to have reasonably good access to capital markets) can already borrow money cheaply to make any investment they would like to make. If they can borrow at 3-4%, then any investment that yields over that makes rational sense to invest in whether or not they get tax breaks. Given this, not clear that giving this demographic more capital will, by itself, make dramatically more investment occur. What tends to spur investment is higher utilization of existing capacity (we are underutilized right now).
      (52 votes)
  • blobby green style avatar for user Jeroen Ooms
    It is not clear to my why the debt is project to go down under the fiscal cliff scenario, even though the deficits is still around 500B.
    (19 votes)
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  • male robot hal style avatar for user Wudaifu
    As a political independent, I appreciate Sal's unbiased presentation. What I want to know is if I am the only one to notice that on virtually every one of these graphs, the trends between 1992-1996 (Clinton) reveal more government revenue & lower deficit spending while the years 2000-2008 (Bush) show huge increases in govt spending and declining federal revenue? The most striking "CLIFF" depicted is the one showing employment plummeting during 2008 under Bush. Obama didn't become President until 2009 and his trends appear to be gradually in the positive directions, albeit at slower rates than we would all probably prefer. Am I missing something from the facts as depicted in black and white?
    (9 votes)
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    • leafers ultimate style avatar for user thissideofparadise
      No, you're right. The facts bear this out. Clinton raised taxes on the wealthy fairly significantly fairly early in his presidency, which resulted in a balanced budget in the later years of his presidency. Bush cut taxes not only for the wealthy but for the middle class, too, fairly early in his presidency, which obviously meant that the government spending increased because less money was coming in. Those tax cuts are still in place, and are the ones Sal refers to in the video.

      You can't draw any simple political analyses from those numbers, though. A moderate deficit isn't necessarily a bad thing, assuming you spend it wisely (think about taking out loans to go to college, which will ultimately increase your income). And Clinton was lucky enough to be president at a time the economy was booming, which--while influenced by his policies--depended on many outside economic factors, too. Bush was a bigger spender than the average conservative, which makes it tough to extrapolate his policies to other Republicans. In short, the economy is complicated.
      (14 votes)
  • piceratops ultimate style avatar for user Steven Pryor
    Starting at around , I get confused by how Sal reads the "Federal Debt Held by the Public" chart. Sal seems to suggest that under the Fiscal Cliff scenario the percentage of Debt to GDP would go down but it looks like the chart suggests the opposite. The blue-ish line that represents the "Alternative Fiscal Scenario" trends upwards. Isn't that the "fiscal cliff" line?
    (3 votes)
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    • old spice man green style avatar for user Alf Lyle
      The Fiscal Cliff scenario is synonymous with the "CBO Baseline". The "Alternative Fiscal Scenario" can be viewed as either the Obama budget or the Republican budget, which net out to the same deficits, just arriving at that deficit differently. I had to get past the concept of the Fiscal Cliff being the Baseline. Normally one doesn't choose falling off a cliff as one's baseline plan; hence the confusion.
      (19 votes)
  • blobby green style avatar for user J M
    Can somebody explain why saving money does not improve the economy?

    Individuals: Apart from hording cash under my mattress, isn't nearly every dollar I deposit in a savings account invested?

    Business: Is the horde of cash being held by corporations the equivalent of storing cash under the mattress, or is this "cash" in reality invested in savings bonds, money market funds, cds, etc? And what about stability! Savings provides a safety net for a rainy day (i.e. the recession), it also can provide a competitive advantage; allowing American companies to better take advantage of big opportunities.

    I understand we need spending, but is their a role that savings can and should play in a true recovery (perhaps not a quick recovery). I'm not sure enticing more and more consumerism, and encouraging more and more spending is the best answer for a long-term robust economy. Spending less than we make is a value that individuals and businesses both should practice. To me it seems a bit of a sad commentary on the middle class that Sal and politicians can say - give it to the middle class, because we know they will spend it.

    I request a new video that specifically talks about savings: Is it good or is it bad?
    (10 votes)
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    • blobby green style avatar for user oscar
      Saving is a good thing, especially in today's economic environment of extremely high debt and consumption. Two points I must share before anything else; the US Government is taxing and borrowing money that would otherwise be invested or spent in the private sector and the Federal Reserve is Monetizing the debt of the US Government with QE until unemployment is below 6.5% buying 70% or more of all Treasuries bonds.

      So when it comes to savings the Federal Government should be the first institution to balance its budget. Interest rates have to rise so to incentivize savings and curb consumption thus restructuring and stabilizing the fundamentals of a sound economy. Only saving to create a pool of real capital will enable entrepreneurs and business to invest and grow the economy and create prosperity for all. Capitalism at its finest fueled by Savings. There must be savings to produce. People are saving in gold. Credit has its role in the economy and a very important role but I’ll save that for another comment.
      (5 votes)
  • male robot hal style avatar for user Danny Thomas
    I have heard a lot from friends about how the government needs to abolish the Federal Reserve and print their own money because the Federal Reserve is not a government body. Is this true? If so, why was the Federal Reserve established? Who are they and what do they do?
    (2 votes)
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    • male robot hal style avatar for user Andrew M
      The Federal Reserve was established by the federal government in the early 1900's. It is a regulated institution that is designed to operate independently from the government so that its decisions about the money supply (and other matters) will not be influenced by politics.

      Watch sal's vids on banking to learn more about the role of central banks like the Fed.
      (6 votes)
  • starky tree style avatar for user imamulhaq
    Why is the US always in debt? The chart shows at .
    (3 votes)
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    • leafers ultimate style avatar for user jkimball
      The answer to this is quite complex. The short answer is that debt is different for a country (which prints its own money and currency) than it is for a person or for a family (which use the money of the country they live in.)

      Debt is not inherently bad- consider the value of having 10,000 dollars ten years ago vs the value of a having a road ten years ago. The road enables growth and opportunities greater than the value of the money, especially over time.

      So the US is always in debt because we believe that the value of the things we buy with the debt will be worth more in the future than the money itself. Because the nation controls the money itself.
      (4 votes)
  • leaf green style avatar for user Jo Whitworth
    Why Is it that our government keep borrowing money from different country's
    (3 votes)
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    • male robot hal style avatar for user Andrew M
      We spend more than we take in in tax revenue. The difference has to come from selling bonds. We allow anyone who wants to buy the bonds to buy them. American citizens ultimately hold a lot of them. Countries that do a lot of trade with the US, like China, have to do something with the dollars they receive. Buying bonds is one option, and its an option that they seem to like fairly well.
      (3 votes)
  • male robot donald style avatar for user BuccoFan
    I don't understand what a deficit is.
    (2 votes)
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    • blobby green style avatar for user Elsa Golden
      A deficit is a lack. Another way to frame deficit is that it is not enough of something, whether time, money, knowledge, hair spray.... My math students think of a deficit as a negative number because deficit spending means to spend more money than you have.
      (2 votes)

Video transcript

In the last video, we gave a basic outline of the different scenarios that might play out in 2013. Or at least the different budgetary proposals on the table from the administration, from the Republicans, and what will happen if they don't come into agreement, which was the fiscal cliff. Which is this fairly unusual situation where the both parties to the negotiation set up this thing that will automatically happen at the beginning of 2013. That it would be painful for both parties, and the thinking being that it'll force them to come, maybe, to some type of an agreement sooner than later. The fiscal cliff is what neither the Republicans or the administration want because it raises taxes, which the Republicans don't want, and, it reduces spending, which the president doesn't want. And the core argument, and we touched it on the last video and we'll go in more depth in this one, is just as we're beginning to recover from our last recession, it might not be useful for our economy to try to suck out $1/2 trillion. So let's think about the different issues at play. So right over here, we have some charts. Most of these are from the Congressional Budget Office. And there's a bunch of assumptions that go into this. And there many people will debate the assumption that they make. But they at least directionally show the right things. So this right over here, this first chart, compares deficits or surpluses. And really, ever since the early 2000s, we've been running deficits. And as we got into the late, I guess, '10s, or 2008, 2010 timeframe, 2009 timeframe. As we went into a financial crisis. When the economy contracts, you get hit in two ways when you think about deficit spending. On one end, you bring in less revenues. The economy is shrinking. And on the other end, you have to spend more. You have to give people more benefits. More unemployment benefits. Things like that. So whenever you see the economy shrink, you will see, naturally, all other things being equal, you will see deficits increase. And that's what you saw right over here. And on top of that, the government is trying to bail things out as doing stimulus spending and all that in order to minimize the effect of the deficit. And that's why you see here in 2008, 2009, we start running significant deficits. Now, what's interesting is what's going to happen going forward. And going forward, there's two of these scenarios right here. There is the CBO's baseline projection and then there's the alternative fiscal scenario. And just to be clear where we, we are entering this phase right over here in 2013. And the baseline projection is essentially if the government takes no more action. And if the government takes no more action, then the fiscal cliff will be triggered. We will essentially have $500 billion less in 2013's deficit. And so what you see here is that the deficits go down dramatically. We have to borrow less on an annual basis. Now, the alternative to fiscal scenario is if we essentially continue-- if we extend our existing spending, and if we continue to extend the Bush era tax cuts, we go along this path. And so if you care a lot about deficits, the fiscal cliff scenario, which is this top line. This is actually the fiscal-- let me write that in a color you can see-- that's actually the fiscal cliff scenario. It actually looks pretty good. Hey, look, we have much, much lower deficits in that scenario than if we were to continue the tax cuts, and if we were to continue the spending. So there that looks like, actually, an argument for the fiscal cliff. Now let's look at this. Now, this is-- we're going to talk about the aggregate debt. When we say deficit, we're talking about the shortfall in a given year. The debt is the aggregate amount that the government owes. So this is federal debt held by the public, historically and as projected in CBO's baseline. And CBO, when they project, they can only do so much in projecting how good the economy might be, or how bad it might be. To a large degree, they extrapolate from where we are right now. And right over here, you see debt as a percentage of GDP. So you could imagine during World War II, we had a lot of debt as a percentage of GDP. See over here after the end of World War II, we start crossing over 100% of GDP as our debt-- the aggregate amount that the government owes. And then it delevered. And then you see this rough trend, roughly from the early '80s until now, where we've had increasing aggregate debt. There were some moments in the late '90s, early 2000s, where we took it down-- very, very, very strong economy. We started running surpluses. We started to pay down some of our debt. But then we hit back on this debt increasing trend line. And once again, if we continue in the alternative fiscal scenario, which is really continuing to do what we do today, which is extend the tax cuts and continue to have roughly the same level of spending, you see that the debt only continues to increase. In the baseline projection-- this is actually the fiscal cliff scenario. This is where no new legislation has passed. Those triggers in which the Bush era tax cuts expire, and the spending cuts that are triggered by the fiscal cliff scenario hit, we run lower deficits. And we actually see that debt, as a percentage of GDP, actually starts to go down. Which is, at least from a balance sheet prospective, seems like a good thing. So these first two charts say, hey maybe this fiscal cliff thing isn't so bad. It will actually significantly lower the deficit on an annual basis. And as a percentage of GDP, we will as a country, delever. Now let's think about the arguments why well, maybe we don't want to be that aggressive when it comes to reducing our deficit, or reducing our debt as a percentage of GDP. This first chart right over here is the-- we'll read it right over here. It's the percent of our population that is employed. And you see right-- so it's a proxy for employment or unemployment. Or, in this case, it's employment. And you see we hit a major recession at the end of end of 2008. You saw the percentage of our population that is employed go down dramatically. We kind of hit bottom over here, and we're having a shaky-- hopefully, a shaky recovery right now. It's not even clear how good that will be. But hopefully we're having a shaky recovery of sorts. And so just as we're starting to recover, it might not be helpful to take, essentially, $500 billion out of the economy in order to pay down debt. So the fiscal cliff scenario might make us go back into a little bit of a lurch. And most economists are predicting about on the order of 1% slower growth if the fiscal cliff scenario were to hit. Actually, most economists-- not 1%, they're actually expecting about a 2% hit to the economy if the fiscal cliff scenario would happen. And rather from going from 1.7% growth, we might go to negative-- a slight recession, slight receding of the economy. So that's obviously not a good scenario that we want to be in. The other chart that I have right over here, these are yields on 10 year treasury notes. This seems like a very technical thing to talk about. But this is essentially the interest. One way to think about it is this is the interest that the government is paying when it borrows money for 10 years. And one of the main arguments for paying down debt is that, if the government keeps borrowing money, it's going to crowd out other borrowers. It's going to make demand for money high. And maybe the supply will be more and more scarce. And interest rates will go up. So a lot of borrowing could make interest rates go up. And then the other idea is, well, if there's a lot of just borrowing and spending going on. And if we don't have a lot of productive capacity, it could also lead to inflation. Or maybe when the government has a huge debt, they have an incentive to try to have inflationary policies. So that in real terms, that debt seems to be less. But when you look at the debt markets, and these are market driven numbers. The Federal Reserve does not control 10 year yields. The Federal Reserve controls short term yields. You see that we have historically low interest rates. So the bond market-- and there's some very smart people who make their living investing in the bond markets, one of the biggest markets, if not the biggest. It is saying it's really not worried about deficits. It's willing to lend to the US government at all time low interest rates. It's not expecting any inflation. If anything, the bond market is saying that the biggest risk in the economy is continued sluggish growth. The biggest risk in the economy is maybe even some form of deflation. So this super low bond yields right over here would be an argument that well, yeah, if you believe what the bond market is saying, we, one, definitely should not suck money out of the economy. And the risks of maintaining high levels of debt might not be as high as some people are saying-- that you're not going to see interest rates and inflation go through the roof tomorrow. Now, if you ascribe to the second point of view that, OK, yes, we should be responsible. We should start to at minimum lower our deficit, and over time, as a percentage of GDP, lower our debt. The other question is, how do you do that? The Republicans would want to do it mainly through spending cuts, while the Democrats would want to do that possibly through spending cuts, but also by letting some of the tax cuts on the wealthy expire, and maybe even adding some other tax. And so these two charts inform some of those positions. And I'm trying to give as balanced of an approach as I can. So for a Democrat, they might look at this chart right over here. And they might say, well, look, average tax rates for the highest income taxpayers-- if you look at a historical basis, it looks like it's relatively low. And a lot of this comes out of the idea that even though the marginal tax rates are higher than what you see here, high income taxpayers-- a lot of their income might be from capital gains, from dividends. Those are taxed at 15%. They also might have a more sophisticated accountants who can get them more deductions. And so that's why you have them paying-- and they're getting more sophisticated as time goes by. And that's why you see this trend going down. And so this could be an argument, well at least relative to historical basis, that this category of folks might be able to afford to pay more. There's also another argument in terms of a stimulus argument, or how to minimize the impact on the economy. So if you have $1 that you want to somehow stimulate the economy with. Well one, the government could spend the money. And there are many arguments-- very good arguments-- why the government is not always the most efficient spender of money, and not always spending it in the best way. But they will definitely spend it. So you give it to the government. You give to the government, they'll definitely spend it, and then some. So they'll definitely spend that dollar. At least it will enter into the economy. Now, if you give it to the middle class, they are also likely to spend it. Or, to spend a good chunk of it-- maybe save a little bit. And the argument would be that if you give it to someone who's affluent, they are likely to save it. Now, saving is not always a bad thing. If you are low on investment, you need more savers. If interest rates were going through the roof right over here. That means that we don't have enough supply of money. In which case, it would make sense that we would try to incent savers. So if you have a situation of-- in the late '70s, where you have inflation going through the roof. You want people to actually invest more. You want a higher supply of money. Makes complete sense to put more money in the hands of people who are likely to save and invest that money. But here, at least if you believe the bond market, it looks like we have a demand problem. That it's actually very cheap to get capital. If anything, there's a surplus of capital out there. But there's not enough demand in order for people to get the economy to run at its potential. So a Democratic argument would be, look, if we're going to have this dollar, the person that we're best off giving it to is the middle class. Or possibly to some degree, the government. Because at least they will spend it. It will help stimulate the economy here, it will go into savings, but that doesn't seem like what the government needs right now. Now, the counter argument that you might get from someone at the right is that, first, the government is just a hugely inefficient spender of capital. And there's a lot of evidence to-- you definitely need a government, but they don't always spend money in the most efficient-- and even sometimes it leads to levels of corruption. And often times, when you do something in the name of stimulus, maybe it might make sense to do it in the short term, but once that program is in place, it's very hard to remove that program. People start to depend on it, even when you, in theory, you don't need the stimulus anymore. It's a very hard to shrink the size of government. And there's some argument for that. If you look at outlays-- government expenditures as a percentage of GDP-- it does look like, on a historical basis, it is high. Now, to some degree, this is due to the fact that we have entered into kind of a major recessionary phase. You see that in all of the major recessions, the government gets less revenue and has to do more outlays. This happens in every-- well, I would say in most recessions. And this happened in dramatic form, where we started to have more outlays. We had-- actually this point, we had wars that we were funding. And we were doing these trillion dollar stimulus packages. And we have these trillion bailouts. At the same time that the economy was receding right over here. But just when you look at this, it does look like the government spending, as a percentage of GDP, is at historical highs. And as we say, as the arguement would have it, it's very hard to get that to shrink, even when it should be shrinking. And it's often being deployed in less than efficient ways. So I will leave you there. My intent really is not to sway you one way or the other. But to really just hope that you have good information when you think about the issues surrounding the fiscal cliff.