CBO warns of approaching ‘fiscal cliff’

WTF CBO fiscal cliff hp 5.24.12

The Congressional Budget Office warned Congress that the nation is heading toward a “fiscal cliff” if steep budget reductions and expiring tax cuts take effect in 2013. 

The CBO’s warning came as members of Congress are increasingly mired in their re-election campaigns while leaving serious tax and budget policies unsettled.

“The longer the adjustments in policies were delayed, the more the debt increased, the greater the negative consequence,” the non-partisan agency cautioned. The combination of the scheduled expiration of the Bush-era tax cuts and the $1 trillion across-the-board “sequester” cuts mandated by the Budget Control Act 2011 set to take place next year will likely push the country into a “mild recession” during the first half of 2013, the CBO concluded.

That combination will lower GDP growth down to 0.5% from the prior projection of 1.1%. (GDP, or gross domestic product, measures all goods and services produced in a country.)

Read more: CBO blames high unemployment on weak consumer spending

“The increases in taxes and decreases in government benefits will lead households to cut back their purchases of goods and services, and the decline in funding for government program will lead to further cuts in purchases. That drop in demand will, in turn, lead businesses to lower their production, employment, and investment,” explained the CBO’s report.

Read more: CBO report shows extending Bush tax cuts will raise deficit

Despite the bad news for the economy in the short-run, the expiring tax cuts and pending sequester cuts to the discretionary budget is expected to reduce the deficit by between $560 billion to $607 billion in fiscal year 2012-13 even factoring in the adverse economic impacts. That would bring down the national debt from 75% of GDP in 2012 to 61% of GDP in 2022.

Most of the deficit reductions will result from the expiring tax cuts. Allowing the tax cuts to expire on Jan. 1, 2013 would reduce the deficit by $399 billion in 2012-13, including $221 billion from the Bush tax cuts, which have largely benefitted high-income and wealthy individuals.

Read more: How the 2001 and 2003 Bush tax cuts benefit the wealthy

The spending cuts would reduce the deficit by $103 billion in 2012-13, with most the cuts – $65 billion – coming from defense and non-defense discretionary programs per the Budget Control Act.

The CBO acknowledged that lawmakers “face difficult trade-offs in deciding how quickly” to reduce the budget deficits.

Imposing fiscal austerity measures and raising tax revenues abruptly would “drag” down the economy, but stretching out the measures over a long period of time would result in higher accumulated debts.

If left unaddressed, higher national debts will harm economic growth in the long-run because more money would be devoted to paying back the debts (and higher interests) instead of investing in businesses and infrastructures that create jobs. The higher debts will also hamper the government’s ability to deal with unexpected challenges in the future, including recessions and financial crises.

Expiring tax cuts would reduce deficits by $399 billion in 2012-13:

  • Bush-era tax cuts and Alternative Minimum Tax: $221 billion
  • Middle Class Tax Relief and Job Creation Act of 2012 & payroll tax cut: $95 billion
  • Other tax cuts: $83 billion
Spending cuts would reduce deficits by nearly $103 billion in 2012-13: 
  • Budget Control Act’s sequester cuts to discretionary spending: $65 billion
  • Emergency unemployment benefits extension: $26 billion
  • Reduction in Medicare reimbursements to doctors: $11 billion

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