CBO Looks Over the Cliff

May 22nd, 2012 at 5:29 pm

That fiscal cliff—you know…the one everyone’s all wound up about?  Well, CBO just released their analysis of its potential impact on the economy and it ain’t pretty.  Add up all the stuff that’s scheduled to turn into fiscal pumpkins at midnight on Dec 31, and you get about 5% of GDP (all the Bush tax cuts, automatic spending cuts, AMT fix, payroll tax cut, UI extension, and more!).

What impact might that have on the economy?  Their best guess is that it means declining real GDP in the first half of next year to the tune of 1.3% (annualized; or around $100 billion through the first half), followed by growth of 2.3% in the second half of 2013, or 0.5% for the full year.  Unemployment would reverse course and start rising it that fiscal scenario remained in place—a big, important “if,” as I’ll return to in a sec.

Suppose Congress enters full can-kick mode and extends everything—a very bad idea, IMHO.  Then, according to CBO, the economy grows 4.4% next year and unemployment reliably continues its recent downward trend.  CBO also estimates a middle-ground extension scenario where the payroll tax break and UI extension expire but most everything else stays with us.  Under that regime, they project growth of about where we are now, around 2%.

By now, if you’re still with me, you’re probably torn—at least I hope you are—between the full-extension scenario to tap the higher growth rate and keep the recovery on track, and the fiscal and inequality-worsening agony of extending the high-end Bush tax cuts, the ones the President very clearly wants to finally sunset.

Well, here’s the thing: CBO doesn’t score that scenario—what would happen to growth if the high-end tax cuts expired—but a) it’s a relatively small share of the full fiscal constraint package—something in the neighborhood of $80 billion in 2013 out of about $600 bn, and b) equally importantly, because these high-income folks are not income constrained, the growth multiplier on their tax cuts is low, about 0.3 (give them a $1 tax cut and their extra spending will raise GDP by between 10 and 50 cents; that’s the lowest of all the stimulus policies CBO evaluated).  If these numbers are roughly right, $24 billion in 2013 foregone stimulus is a very small price to pay for permanent sunset of this part of the Bush tax cuts—and I say that as a guy who really doesn’t like forgoing stimulus what with all this slack still in the system.  

Finally, that big “if” I mentioned above.  All of these estimates assume we go off the cliff and don’t climb back.  If, as Gail Collins imagines it, there’s a bungee jump instead of a cliff dive, we can avoid the worst of this. 

One hopes the Congress can hammer the kind of compromise that has eluded them thus far—the one that adds tax revenues to any agreement—before the end of the year.  But if that doesn’t happen, a retroactive agreement by the new Congress very early next year could work too.

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3 comments in reply to "CBO Looks Over the Cliff"

  1. Christopher C. says:

    It seems to me another good solution, which I haven’t heard mentioned, is to mitigate the effects of the cliff from the full set of tax deductions expiring by taking a good chunk of the revenue generated and turning it into targeted fiscal stimulus – aid to states, infrastructure projects, etc.

    Is $1 spent well as stimulus worth more to GDP than having that $1 stay in my paycheck?


  2. AJS says:

    Hi Jared

    We often hear politicians (e.g. in UK and US) talking about the government as if it is a household, as if ‘there is no money left’. But this just does not seem to make sense for the countries that are issuers of their own currency. I realise they play a game with the fed.

    Surely the key is to watch out for inflation and unemployment – the rest is about distribution in order to encourage real wealth creation (say investing in education etc.)

    So – is a government like a household, i.e. can it run out of money?

    many thanks
    Alex


    • Jared Bernstein says:

      No, gov’t's are not like HH’s–not even close…I’ve got many posts on this, particularly on the very unfortunate analogy of belt tightening.


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