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CBO: Going over the fiscal cliff is bad, but so is ignoring the national debt

The Congressional Budget Office warns in a report Thursday that allowing tax hikes and spending cuts to occur – going over the fiscal cliff – could cause a recession.

America’s budgetary scorekeepers have published a postelection “FYI” for the president and Congress, with this blunt message: That “fiscal cliff” thing is dangerous, but so is the opposite policy of ignoring the national debt.

“Fiscal cliff” is the nickname for a collection of tax increases and federal spending cuts that are scheduled to take effect at the start of next year.

Economists at the nonpartisan Congressional Budget Office (CBO) warned in a report Thursday that allowing those tax hikes and spending cuts to occur “will probably cause the economy to fall back into a recession next year.”

But, the CBO report added in the next breath, letting the policy changes take effect would actually “make the economy stronger later in the decade and beyond.” The reason: The tax hikes and spending cuts would reduce federal deficits, thus avoiding a dangerous surge in federal debt as a percentage of gross domestic product (GDP).

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What this implies is that there’s a very tricky job ahead for a Democratic president, a Republican-led House, and a Democratic-majority Senate.

The ideal way forward, suggested in the CBO report and in other independent reviews, would be to change the cliff into a gradual slope – one that avoids recession in the near-term but still leads down a path of deficit reduction. It’s not just a matter of saying, “Let’s postpone those tax and spending changes.”

Elected officials in both parties have endorsed the general idea of long-term fiscal reform. But the choices are difficult. The new report, titled “Choices for Deficit Reduction,” makes a big deal of that.

It talks about various options for reducing entitlement benefits, cutting other federal spending, or raising new tax revenue. A mix of those approaches may very well be needed, the CBO implies, because of the magnitude of the mismatch between expected revenues and spending.

The report is both a nudge to action and a partial tool kit for lawmakers as they bargain in the coming days and weeks.

Some overview points from the report and other recent CBO analysis:

• The option of doing nothing isn’t pretty. If policymakers push the economy straight over the cliff on Jan. 1, a recession would probably result, yielding a decline of 0.5 percent in GDP for the calendar year. The unemployment rate would shoot up to 9.1 percent, the CBO predicts.

• The option of fully removing the cliff would result in an economy that grows, but not at a roaring pace. A separate analysis released Thursday by the CBO estimated that keeping Bush-era tax rates in place, nixing the cuts in defense and other spending, and making other changes (including extending payroll-tax relief for workers) would push GDP up to a growth rate of about 2.4 percent.

• But fully removing the cliff adds a lot to the federal deficit. Spending would exceed revenue by an extra $503 billion in 2013. That’s equal to more than 3 percent of a year’s GDP.

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• Doing nothing to stem the red ink would have long-term consequences. The CBO outlines negative effects including an impaired ability to respond to unexpected challenges, as well as “an increase in the likelihood of a fiscal crisis, in which investors would lose confidence in the government’s ability to manage its budget, and the government would thus lose the ability to borrow at affordable interest rates.”