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CBO on ‘fiscal cliff’: newest estimate is gloomiest yet

The CBO, Congress’s budget watchdog, warns that the US economy will ‘probably’ slide back into recession, if the tax hikes and spending cuts mandated for year’s end take effect.

Every time the Congressional Budget Office recalibrates its projections for the economic impact of the nation’s impending “fiscal cliff,” the picture gets bleaker.

That’s the headline news from Wednesday’s CBO update on its budget outlook for the next decade: The $560 billion mix of spending cuts and tax hikes that make up the year-end fiscal cliff will “probably” cause a recession in 2013, as the economy would shrink by 0.5 percent for the year.

And not only are the impacts of going over the cliff worse, but the CBO also believes the American economy will be weaker overall even if Congress punts on all of the nation’s pressing issues of taxing and spending by pushing off the expiration of tax breaks and the beginning of spending cuts for a year or longer.

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Why? First, the economy is not moving as quickly as the CBO expected it would early in 2012. Second, policies enacted after the CBO’s early-year forecast, such as a one-year extension of the payroll tax cut and emergency unemployment benefits, helped GDP growth this year but their expiration at year’s end will lower it in 2013. 

Moreover, uncertainty about how the fiscal cliff will play out is already hurting spending by both businesses and consumers. The CBO’s 2012 economic outlook holds that some households will “probably pull back on spending later in the year in response to rising concerns about the effects of the future fiscal tightening.”

Likewise, while business investment is currently growing “strongly” and is “supported by favorable conditions in markets for corporate borrowing,” it is also being “restrained by businesses’ concern about possible major changes in fiscal policies.”

Many economists have recently ascribed at least some part of the slowing economy to uncertainty over the fiscal cliff, as the Monitor previously reported.

Congress’s nonpartisan budget analysts now project the economy will contract by 0.5 percent between the fourth quarter of this year and the same quarter in 2013, if the economy is allowed to sustain some $560 billion in higher taxes and lower spending.

In May, the CBO said the economy would shrink by 1.3 percent in the first half of next year before rebounding to 2.3 percent growth in the second half for a yearly gain of 0.5 percent.

In January, the CBO estimated that the economy would grow by 1.1 percent even if it went off the fiscal cliff.

Going off the fiscal cliff would increase the unemployment rate a notch more than previously expected. Without congressional action, unemployment would breach 9 percent come December of 2013. Previously, CBO expected it to come in at 8.8 percent.

Even if Congress pushes off a reckoning with these budget issues for a year or longer in order to give them even more time to negotiate a solution, CBO believes the economy will be weaker next year than it previously thought. Annual economic growth with a congressional punt on the fiscal cliff would hit an anemic 1.7 percent in 2013 versus the CBO’s May estimate of 4.4 percent growth.

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A 1.7 percent growth rate would be slower than the 2.1 percent growth the CBO expects the economy to clock in at this year.

As in previous reports, the CBO noted that allowing the tax hikes and spending cuts of the fiscal cliff to come to pass will dramatically shrink the nation’s deficit in coming years. In 2013, for example, the deficit would be $641 billion (or 4 percent of GDP) if the US hits the cliff head-on versus an estimated deficit of $1 trillion (6.5 percent of GDP) if current taxing and spending policies are extended.

Allowing fiscal cliff-like fiscal policy to continue for the next decade would lower US deficits to just 0.9 percent of GDP in 2022 with the nation’s overall debt falling from 77 percent of GDP in 2014 to 58 percent in 2022. That’s versus a deficit averaging 5 percent of GDP over the next decade if current tax laws are extended and spending cuts are eliminated, with America owing 90 percent of its GDP in debt come 2022. (CBO graphic is here.)