The Congressional Budget Office is out with their economic projections for the fiscal cliff. They pretty much match Goldman Sachs’ prediction from last week, but these are the numbers Congress is likely to parrot for the next 6 months, so we’d better take a look.
CBO projects that $607 billion in deficit reduction items are at stake at the end of 2012, when various tax and spending measures expire. Because the cuts will begin at the beginning of the calendar year and not the fiscal year, we’re talking about a substantial cliff:
Most of the policy changes that reduce the deficit are scheduled to take effect at the beginning of calendar year 2013, so budget figures for fiscal year 2013—which begins in October 2012—reflect only about three-quarters of the effects of those policies on an annual basis. According to CBO’s estimates, the tax and spending policies that will be in effect under current law will reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013 (with the resulting economic feedback included, the reduction will be smaller).
When they refer to economic feedback, CBO means that federal revenues will shrink as a result, because economic growth will be stunted and unemployment will rise. In fact, CBO predicts a recession for the first half of 2013 if all the items on the fiscal cliff are allowed to go through.
Under those fiscal conditions, which will occur under current law, growth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5 percent, CBO expects—with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession.
This represents about a 4% drop in GDP for 2013. In fact, CBO projects that GDP would grow 4.4% in 2013 if everything is extended a year. That includes the payroll tax cut, which nobody actually expects to be extended.
I do question the 4.4% growth projection, which is sunnier than virtually every economic analysis I’ve seen. But the 4% drop in overall GDP fits with other data. On the flip side, extending the policies indefinitely would raise the debt to GDP ratio, whereas allowing the policies to expire would lower that ratio.
CBO sets this up as a choice: risk a recession in the first half of 2013, or risk a larger debt crisis down the road. Those are not the only alternatives.
For example, letting the Bush tax cuts expire and then coming back with a different set of “Obama tax cuts” could reshape the tax code to promote a healthy middle class, while taking in more revenue. Eliminating tax cuts at the high end would hardly affect growth to any real degree; Jared Bernstein puts it at about $24 billion in “foregone stimulus” for 2013, and I think the number could be lower; you’re talking about tax cuts that largely are going into bank accounts, which for the truly wealthy should not impact their spending whatsoever. The key about a tax cut expiration policy is that it’s not like the fiscal impact of expiration starts pounding within a week; you could design a retroactive policy, where the Bush tax cuts are dead and buried and pressure is put on Republicans to pass a new round of tax cuts to avoid recession.
That won’t be entirely true, however. I wrote yesterday that Washington is calling this choice at the end of the year “Taxmageddon,” but the taxes are not the real issue; it’s the trigger cuts and the expired unemployment insurance, which would hit growth much harder than the taxes. Those would have to be dealt with in that calendar year; I would doubt that you could get retroactive trigger restoration after the fact.
CBO offers the option of “changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period,” and that’s basically the grand bargain strategy. But CBO is not specific about it.
And granted, all of this makes far too many assumptions about the November elections and who will actually be in office come the following year.