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How to Explain the Fiscal Cliff to Your Kids (and Yourself!)

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Everyone is tired of hearing the phrase "fiscal cliff" and you may think it's old news, so why should you explain it to your kids? Because it is a good opportunity to revisit your lessons on family finance and budget.

The "fiscal cliff" is a term generally credited to Ben Bernanke, chairman of the Federal Reserve -- the central bank of the United States. It is used to describe the meeting of two events which had been scheduled for December 31, 2012 -- the expiration of nearly all tax cuts enacted since 2001 and a scheduled (severe) reduction in government spending. It is widely believed that if both of these were allowed to occur it would likely have bankrupted the country.

Begin by cutting through financial jargon to break down the country's financial problems in simple terms. The government has a budget like you have at home. A budget tracks "money in," which is money earned, and "money out," which is money spent. Explain to your kids that if you spend more than you earn, and borrow more than you can repay, you go broke.

Just like a household, governments earn their money by receiving income. In a household, you receive income by working -- kids earn money by doing chores and earning an allowance.

Governments earn money in different ways including charging people taxes on the money they earn. These taxes are used to pay for things like roads, schools, bridges and so many other things we use every day -- and services like police and teachers. All of us in this community use these roads, so we all need to see that they are taken care of somehow. Tell your kids that we have to give money to the government to make sure that we can have these roads to drive on, police to protect us and schools so we can learn.

Unlike households, the government gets to print money if it wants to -- we can't do that. The government can spend more than it earns because people who have lent it money trust it will be able to figure out how to pay it back. Also, a government has the benefit of being trusted because of the reputation of the whole country, so it can borrow more than it owes.

In a last-minute fix, a compromise was reached on the tax component. Don't get too excited, because the spending cuts deadline was merely postponed until March 2013 -- so get ready forFiscal Cliff Part Two, the Sequel -- coming soon to every news outlet near you! What some people have missed is that the sequel has to do with whether we are going to pay our existing debts and not take on more debt.

With only half the job done on the metaphorical cliff, is it any wonder that Congress has an approval rating of 14 percent, or that many would like to see them fall off an actual cliff?

As I have discussed in previous blogs, I am an advocate of teaching our kids to budget their allowance. An allowance system operates on a "work for pay" principle. Take the focus of your discussion back to your child's own budget.

First, review your child's budget with him. There are four components to my budget system: Charity, Quick Cash, Medium-Term Savings and Long-Term Savings. Ten percent of all money the children earn should go to charity. Then divide the balance among the remaining three categories. Ask your kid what his Medium-Term and Long-Term savings are earmarked for. Yes, I take on taxes after dealing with basics.

Suggest an hypothetical physical cliff scenario with your child -- "What happens if you have used all your Quick Cash, you find your friends are going to that blockbuster movie and you want to go, too?"

There are two universal solutions you can offer:
  • Cut Spending: in this case, postpone seeing the movie until you can afford it, or invite friends in for a DVD night.
  • Increase Revenue: maybe there are additional chores to be done to make extra cash.

Be sure to remind them that Money Doesn't Grow on Trees -- unless you're the government. By the way, I teach these lessons in my New York Times #1 Best Seller, "Money Doesn't Grow on Trees."

If you have questions or comments, I'd like to hear from you in the space provided below.