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What's This 'Fiscal Cliff' Anyway? Do I Need to Worry?

By Jeff Cox, Senior Writer

NEW YORK ( CNBC) - " Fiscal Cliff" is a term you'll be hearing much more often between now and the end of the year. That's when a half-trillion dollars worth of tax cuts and spending boosts go by the wayside, possibly dragging the U.S. economy into the abyss of another recession.

That, however, is the worst-case scenario.

A more likely outcome, according to those who have studied the issue closely, is that Washington officials come up with a way to extend many of the items in question before automatic tax increases and spending cuts kick in that could choke the life out of the already-stumbling recovery.

Global policy makers have done it during the financial crisis of 2008, the U.S. budget imbroglio in 2011, and throughout the European sovereign debt disaster.
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For the fiscal cliff, there are four main items at issue: Expiration of the Bush tax cuts; the end of the 2% payroll tax holiday; extended unemployment compensation coming to a close; and the automatic spending and budget cuts mandated by the Budget Control Act if Congress fails to reach its Supercommittee's deficit reduction goals.

All told, the damage would amount to $500 billion, or some 3.8% of gross domestic product, at a time when GDP is struggling to grow by 2%.

While it all sounds pretty scary on the surface, in practice it's unlikely that anyone in Washington will be content to sit by and allow another deep recession to hit.

"We do not see the doomsday scenario playing out: policymakers are unlikely to drive the US economy off the fiscal cliff," JPMorgan Chase (JPM) economist Michael Feroli said in an analysis. "Nonetheless, fiscal policy will continue to be a drag on the economy next year."

For a firm that does not believe the worst of the cliff scenario will come to pass, JPM has done extensive analysis of its ramifications.

The conclusion: While the markets may rattle and roll over the doomsday scenarios, the end result will be a buying opportunity.

"We anticipate the market will show a smaller-amplitude reaction to the political drama developing around the US fiscal cliff," said Thomas J. Lee, JPMorgan's chief market strategist. "The fiscal cliff is enormous...but there is sufficient common ground to expect much of this to be delayed."
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