What is the 'fiscal cliff' in the US and its implications?

The "fiscal cliff" is a combination of dramatic spending cuts and tax increases mandated to take effect in January if US President Barack Obama and Republicans cannot bridge their differences on how best to reduce America's budget deficit and debt. To add to a drama that could reverse the slow domestic recovery and impact the global economy, the US is also about to reach its borrowing limit.

What happens if the cliff is not avoided: Together, higher taxes and lowered spending could slice the US$1.1 trillion deficit racked up in the financial year ended September 30 by almost US$500 billion next year, according to the Congressional Budget Office (CBO), vastly improving the government's financial picture. But the CBO estimates the shock treatment would send the US back to recession and push the jobless rate to 9.1 per cent.

Who would be affected: Deep cuts would come to defence and non-defence spending. Government suppliers and contractors would lose business, and tens of thousands of federal employees could face temporary lay-offs. Taxes and automatic pay-cheque deductions would rise for most Americans, reducing the cash they have for spending, and taxes on capital gains and dividends would increase, hitting investors.

What is the debt ceiling: The US government will hit its statutory US$16.39 trillion debt limit on Monday. If it is not raised, the US will not be able to borrow any more money and would, in theory, be forced to slash spending to make ends meet.

What would default mean: The country's credit rating could be further downgraded, likely pushing up its borrowing costs over the medium term and possibly diminishing the dollar's cachet in world finance.

What about the markets: According to some analysts, the US markets are already discounting a negative outcome. Since the US economy is a primary driver of the global economy, we could see the world markets slow down if the US goes over the fiscal cliff.