The Congressional Budget Office released an update to their fiscal projections for 2012 to 2022. And it shows that the US will carry a $1.1 trillion budget deficit this year, down from their earlier projection of $1.2 trillion. As a percentage of GDP, the 2012 deficit will be 7.3%, down by 1/4 from the Fiscal Year 2009 deficit. Some of that is due to an improved economy leading to slightly smaller reliance on mandatory benefits. Some of that is due to revenue increases from the recovery. But a substantial chunk of that is due to spending cuts.

The interesting part of the CBO report, what most policymakers will focus on, concerns the baseline scenario for the next fiscal year (begins September 2012), under the policies of the fiscal cliff. If Congress does nothing, the deficit will shrink almost in half, to $641 billion from $1.1 trillion. However, this would also lead to a recession. If all the tax increases and spending cuts kicked in, GDP would decline by 0.5% through 2013, according to CBO, if nothing else happens, and unemployment would rise back to 9% by the end of next year.

CBO also sketches out an alternative fiscal scenario, where almost everything in the fiscal cliff gets pushed out:

To illustrate the consequences of possible changes to current law, CBO has produced projections under an alternative fiscal scenario that incorporates the following assumptions: that all expiring tax provisions are extended indefinitely (except the payroll tax reduction in effect in calendar years 2011 and 2012); that the AMT is indexed for inflation after 2011; that Medicare’s payment rates for physicians’ services are held constant at their current level; and that the automatic spending reductions required by the Budget Control Act, which are set to take effect in January 2013, do not occur (although the law’s original caps on discretionary appropriations are assumed to remain in place).

That set of alternative policies would lead to budgetary and economic outcomes that would differ significantly, both in the near term and in later years, from those in CBO’s baseline:

In 2013, the deficit would total $1.0 trillion, almost $400 billion (or 2.5 percent of GDP) more than the deficit projected to occur under current law.
The economy would be stronger in 2013: Real GDP would grow by 1.7 percent between the fourth quarter of 2012 and the fourth quarter of 2013, and the unemployment rate would be about 8 percent by the end of 2013, CBO projects.

This is actually a bit more damning. CBO is saying that, even if Congress avoids the fiscal cliff, the deficit would shrink by about $100 billion year-over-year, GDP would remain below the historical trend of 2.5%, and unemployment wouldn’t budge from today’s numbers. That’s if fiscal policy DOESN’T contract to a major degree. The whole thing suggests a fairly phlegmatic economy that needs but is not likely to get more government spending to boost aggregate demand.

Under a current-law baseline – i.e. the implementation of the fiscal cliff – the deficit almost goes away entirely by 2018, before rising slightly by 2022, and the debt-to-GDP ratio drops to a manageable 58%. This is mostly because revenues would rise back to around 21.4% of GDP in 2022, with the expiration of the Bush tax cuts. Spending, in addition would project out as a smaller share of GDP in 2022 (22.3%) than in 2012 (22.9%). So spending would be constrained by the artificial spending cap agreed to in the debt limit deal. “By CBO’s estimate, discretionary spending will fall to 5.6 percent of GDP by 2022—the lowest level in at least 50 years,” the report says. Mandatory spending, mostly because of health costs, would rise, but not appreciably, from 13.2% of GDP in 2012 to 14.4% of GDP in 2022. Of course, if Congress pushes off the fiscal cliff, many of these assumptions go out the window.

Dylan Matthews adds that the Bush tax cut expiration really drives the debt reduction in the CBO’s scenarios.

This implies that you can put together a deal where policies that keep the economy afloat at lower cost are extended and those whose budget cost outweighs their economic benefits are allowed to expire. For instance, I found using CBO multipliers that letting all the Bush tax cuts expire but extending current spending and the payroll tax holiday reduces GDP by about 1 percent — a big number, but much less than the 3.9 percent decline from doing nothing altogether.

This should be on the minds of policymakers heading into the lame duck session.

UPDATE: The White House responded to the report by saying that Congress should implement its tax-increase package for the wealthy.

Today’s Congressional Budget Office report only reinforces the urgent need for House Republicans to follow the Senate’s lead and pass a bill that gives middle class families the confidence that they won’t see their taxes go up at the beginning of next year. 114 million Americans deserve that guarantee.

But instead of doing the right thing, Republicans in Washington have chosen to double down on the same failed policies that led to the economic crisis in the first place. They’re willing to hold the middle class hostage unless we also give massive new tax cuts to millionaires and billionaires – tax cuts we can’t afford that would do nothing to strengthen the economy.

Congress also needs to act right now to prevent arbitrary spending cuts that would hurt military families, seniors on Medicare, and children who deserve a quality education. It’s time to replace these cuts with balanced deficit reduction that asks the wealthiest Americans and largest corporations to go back to the tax rates they were paying under Bill Clinton – back when our economy created 23 million new jobs and a record surplus. But first, Republicans in Washington should do the right thing and pass a bill that extends tax cuts for 98% of Americans and 97% of small businesses. There’s no reason to wait.

Of course, just ending the Bush tax cuts over $250,000 in income would still extend the lion’s share of revenue reductions, which means deficits would continue without cuts as part of the ominous-sounding “balanced deficit reduction.”