Why the Fiscal Cliff Will Crush Business

Check the Top Stories section at Fool.com each day for our latest fiscal-cliff coverage. We won't stop till the madness does. To read previous stories in this series, follow the links at the end of this article.

It's the most talked-about issue in America these days, and it will continue to be until legislation is passed to prevent it -- or until the nation falls off it.

Hello, fiscal cliff.


While Americans fear the higher tax rates slated to hit individuals next year, businesses will have a tough time going over the cliff as well. Just how bad will the effects be? Bad enough that you'll hear the word "recession" being tossed around on your TV again.

Not another recession!
Don't take it from me; take it from the Congressional Budget Office. The CBO estimates that gross domestic product would contract by an annual rate of 1.3% during the first half of calendar year 2013 and concludes that the National Bureau of Economic Research would find this sufficient to drop the economy into recession status. For the full calendar year, the CBO expects 2013 GDP to increase by just 0.5%, buoyed by an expansion in output of 2.3% for the latter half of 2013.

The scheduled expiration of the Bush tax cuts makes up the lion's share of what will slam GDP, but there are plenty of factors at work here.

Fiscal-Cliff Provision

Estimated Effect on Deficit Reduction

Expiration of Bush tax cuts

$221 billion

Expiration of payroll tax

$95 billion

Expiration of "various other provisions affecting the tax code"

$65 billion

Sequestration

$65 billion

Expiration of unemployment benefits

$26 billion

Affordable Care Act taxes

$18 billion

Medicare payment reduction

$11 billion

All other changes

$107 billion

Gross Impact

$607 billion

Fiscal-cliff-caused deficit increase

$47 billion

Net Impact

$560 billion

Source: Congressional Budget Office.

While the gross total comes to $607 billion, the fiscal cliff is expected to inflict an extra $47 billion in deficit spending due to the need for more unemployment insurance and other spending, as well as lower taxable income.

While budget cuts sound appealing to some people, this lacks the finesse that carefully tailored cuts could bring. Instead, we have the legislative version of fruitcake: disparate ingredients combined together in a way few find palatable -- yet eat it, we must. The expiration of George W. Bush's tax cuts and wholesale budget cuts could lead to recession. Investment firm Keefe, Bruyette, & Woods forecasts 2013's first-quarter GDP contracting by 1.5%, and Morgan Stanley sees three straight quarters of economic contraction with the fiscal cliff in place, alongside a plunge in global GDP of 2% for the year.

Unemployment's not a pretty picture, either. KBW projects that figure to rise to 9.1% under the fiscal cliff, which is made even worse for laid-off Americans, given that some federal unemployment benefits are scheduled to expire with the cliff's arrival.

What happens if Congress punts the fiscal cliff years down the line, delaying the scenario? While the CBO estimates real GDP growth of 4.4% in 2013 -- a nice number, to be sure -- avoiding a fiscal solution to the rising national debt in the long run would hurt the economy with higher government interest payments and the increased possibility of a massive, sudden fiscal crisis and a reduced ability to battle it.

The economy is stuck between a rock and a hard place. If Congress can't agree to a solution for the cliff now, we're in for an even worse beating later. The markets haven't been any more trustworthy, what with their recent wild swings over fiscal-cliff fears. But how will this doomsday scenario affect industries and companies?

Getting defensive
Laid-off Americans could be getting company, as defense contractors have made no attempt to hide planned layoffs. Boeing has already initiated job cuts at its defense division, and the impact of sequestration -- the mandated federal cuts set to arrive in 2013 -- will send shockwaves through the entire industry.

The Pentagon is already facing expected budget cuts of $500 billion over 10 years, but sequestration would add another $497 billion in cuts over that time. High-priced projects would thus take a major hit over the long haul, with companies such as Northrop-Grumman and General Dynamics that make tanks, warships, and other expensive material likely to see orders decrease.

While Lockheed-Martin's CFO expects sequestration to have only a minimal impact on the company's massive and costly F-35 project, expect the defense sector's largest player to take its share of hits. With operations and maintenance outlays from the Department of Defense projected to be reduced by nearly 7%, Lockheed's operations-heavy divisions, such as its electronics systems branch, could be heavily hit.

Nobody's safe
It's not just the defense sector that will be struck by budget-cut blues, however. Nondefense sequestration will also go into effect, hurting education, the Department of Labor, and other areas. In a report on the subject (link opens PDF), Iowa Sen. Tom Harkin projects 400,000 fewer Americans will receive job training due to cuts at the Labor Department.

Combined with the unemployment picture painted by KBW, the fiscal cliff will slam the average American's pocketbook -- and it won't stop with consumers. The White House has already said that fears over the fiscal cliff could stunt holiday shopping. Should the cliff actually come to pass, retail giants such as Wal-Mart and Target could see declining growth as consumers keep a closer eye on purchases.

Businesses -- and business leaders -- are also getting nervous. Many companies are selling divisions and businesses to avoid potential tax liabilities set to hit in 2013, and should the fiscal cliff hit, it's reasonable to project lower investment due to the tax hits on returns. Companies instead have turned conservative, slowing hiring and contributing to the bleak unemployment projection from KBW.

In a completely different sector, health care stocks could also take a beating from the fiscal cliff. The Food and Drug Administration could lose nearly $200 million under sequestration in 2013, which could severely slow its review of new drugs. That would have a crippling effect on small, up-and-coming biotech companies awaiting FDA approval for drugs that could make or break their futures.

Additionally, the cliff's projected reduction in Medicare reimbursements would harm the entire sector. Healthcare insurers like UnitedHealth Group would see a 2% cut to Medicare reimbursements, and hospitals and medical professionals would also be hit. That's bad news for companies on the cutting edge of medical technology, like Intuitive Surgical and its competitors in the robotic-surgery industry. With less money to spend, hospitals would be far more likely to avoid large investments such as Intuitive's highly successful da Vinci surgical suite.

The ball's in your court, Congress
That's a lot of bad news coming from the fiscal cliff. Very few companies -- and stocks -- are safe from the cuts and tax increases, and defense companies, industries reliant on economic growth, and those reliant on consumer spending are at particular risk of catastrophic effects. In all this mess, one thing is patently clear: If Congress can work together, find a solution to avoid the fiscal cliff, and begin to responsibly control the debt, the future will be brighter for all of us.

Here's hoping that comes to pass.

The series continues
Check back tomorrow for our final installment of the fiscal cliff series: How would you avoid the cliff?

link

The article Why the Fiscal Cliff Will Crush Business originally appeared on Fool.com.

Dan Carroll has no positions in the stocks mentioned above. The Motley Fool owns shares of General Dynamics, Intuitive Surgical, Lockheed Martin, and Northrop Grumman. Motley Fool newsletter services recommend Intuitive Surgical and UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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