This refers to the simultaneous expiry of tax breaks and the introduction of tax increases and spending cuts that were due at the end of 2012, the cumulation of which were expected push the US back into recession.
Among the fallout feared – if Congress failed to reach a deal before December 31 (2012) – was a significant increase in taxation on investment income, with tax rates on capital gains set to increase from 15 per cent to 20 per cent, and tax rates on dividends slated to rise to 39.6 per cent for top earners.
Adding a 3.8 per cent surtax on investment income for the wealthiest Americans – those with adjusted gross income (AGI) of more than $250,000 for joint filers and $200,000 for single filers – was part of the 2010 health reform law and was due to take effect in 2013. It meant tax rates on capital gains would rise to 23.8 per cent, while those on dividends would increase to 43.4 per cent for the highest earners.
If Congress took no action by January 1, the US would be hit by a fiscal contraction worth $600bn in 2013, which could tip the economy into a new recession. The fiscal drag results from the expiry of a series of Bush-era tax cuts, as well as the scheduled entry into force of automatic cuts to defence and domestic spending programmes. At roughly the same time, US lawmakers would have to raise its borrowing limit, or face the risk that the country could default on its debt.
In fact a compromise was reached on January 1 and higher income tax rates were agreed for the wealthy. However, the tougher decisions on spending cuts were expected to fought over for months to come.
In September 2013 a new deadline of the middle of October was approaching. The White House, under president Barack Obama, was determined not to give ground, but if agreement to raise the borrowing authority could not be reached with Congress the US faced a new threat of default on its debt obligations.
At the beginning of October 2013 the US shutdown had started, resulting in the closing of numerous government agencies. But an FT report found that the risk of US default on $1.2tn of outstanding government bonds was worrying markets far more than the shutdown.