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CBO Predicts Impact of “Fiscal Cliff” Greater Than Previously Thought

May 25, 2012—The Congressional Budget Office (CBO) May 22 released an analysis that projects the economic impact of the pending “fiscal cliff” would slightly be greater than previously predicted and “would probably be judged” a recession.

Under current law, CBO projects the federal budget deficit to decrease dramatically between calendar years (CYs) 2012 and 2013, resulting in what some observers have referred to as a “fiscal cliff.” Recent or scheduled expirations of tax provisions, such as those that lower income and payroll tax rates and limit the reach of the alternative minimum tax (AMT), will boost tax revenues considerably in 2013, and the automatic enforcement procedures established in the Budget Control Act of 2011 (P.L. 112-25) will lower spending in 2013 compared with outlays in 2012.

Taken together, CBO estimates these policies will reduce the federal budget deficit by $607 billion, or 4.0 percent of gross domestic product (GDP), between fiscal years (FYs) 2012 and 2013. CBO states, “The resulting weakening of the economy will lower taxable incomes and raise unemployment, generating a reduction in tax revenues and an increase in spending on such items as unemployment insurance.”

Under these fiscal conditions, CBO expects growth in inflation-adjusted (real) GDP in CY 2013 will be just 0.5 percent, including a projected 1.3 percent decrease in the first half of the year. CBO notes, “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 projection slightly is less than CBO’s January estimate of real GDP rising by 1.1 percent in CY 2013.  CBO attributes this decrease to the enactment in February of extensions through the end of CY 2012 of emergency unemployment benefits and a 2-percentage-point cut in the employee’s portion of payroll taxes.

If lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit between CYs 2012 and 2013, CBO estimates the growth of real GDP in CY 2013 would lie in a broad range around 4.4 percent. However, CBO cautions that “eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years would reduce output and income in the longer run relative to what would occur if the scheduled fiscal restraint remained in place. If all current policies were extended for a prolonged period, federal debt held by the public…would continue to rise much faster than GDP. Such a path for federal debt could not be sustained indefinitely, and policy changes would be required at some point.”

CBO acknowledges “policymakers face difficult trade-offs in deciding how quickly to implement policies to reduce budget deficits. On the one hand, cutting spending or increasing taxes slowly would lead to a greater accumulation of government debt and might raise doubts about whether longer-term deficit reduction would ultimately take effect. On the other hand, implementing spending cuts or tax increases abruptly would give families, businesses, and state and local governments little time to plan and adjust. In addition, and particularly important given the current state of the economy, immediate spending cuts or tax increases would represent an added drag on the weak economic expansion.”


Dave Moore
Senior Director, Government Relations
Telephone: 202-828-0559


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