Thursday, November 08, 2012

New CBO report on "Fiscal Cliff"

by Bill McBride on 11/08/2012 05:12:00 PM

Note: My baseline forecast assumes a compromise on the fiscal slope (more of a "slope" than a "cliff", and January 1st is not a drop dead date). My current guess is an agreement will be reached AFTER January 1st - so that the Bush tax cuts can expire and certain politicians can claim they didn't vote to raise taxes (silly, but that is politics).

I expect the relief from the Alternative Minimum Tax (AMT) will be extended, the tax cuts for low to middle income families will be reenacted, and that most, but not all, of the defense spending cuts will be reversed (aka "sequestration"). However I think the payroll tax cut will probably not be extended, and tax rates on high income earners will increase a few percentage points to the Clinton era levels. 

It wasn't worth spending much time on this before the election, but now the details will be important.  As the CBO notes, a policy mistake could lead to economic contraction (a new recession), but I think some reasonable agreement is likely.

From the Congressional Budget Office: CBO Releases a Report on the Economic Effects of Policies Contributing to Fiscal Tightening in 2013

Significant tax increases and spending cuts are slated to take effect in January 2013, sharply reducing the federal budget deficit and causing, by CBO’s estimates, a decline in the nation’s economic output and an increase in unemployment. What would be the economic effects of eliminating various components of that fiscal tightening—or what some term the fiscal cliff?

To answer that question, today CBO released a report—Economic Effects of Policies Contributing to Fiscal Tightening in 2013. This report provides additional details about the agency’s estimates—originally released in its August report An Update to the Budget and Economic Outlook: Fiscal Years 2012–2022—of the economic effects of reducing fiscal tightening.

As CBO projected in August, the sharp reduction in the deficit will cause the economy to contract but will also put federal debt on a path more likely to be sustainable over time. If certain scheduled tax increases and spending cuts would not take effect and current tax and spending policies were instead continued, the economy would grow in the short term, but the government’s debt would continue to increase.

This report focuses on the economic effects of eliminating individual components of the changes in policy that are scheduled to take effect: the automatic reductions in defense spending; the automatic reductions in nondefense spending and the scheduled reductions in Medicare’s payment rates for physicians; the extension of certain expiring tax cuts and indexation of the alternative minimum tax; and extension of the payroll tax cut and emergency unemployment benefits.

Eliminating the first three of those changes—which would capture all of the policies included in CBO’s “alternative fiscal scenario”—would boost real (inflation-adjusted) gross domestic product (GDP) by about 2¼ percent by the end of 2013. Eliminating all of those changes would boost real GDP in 2013 by about 3 percent. The bulk of that impact would stem from changes in tax policies, CBO estimates

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