With the impending fiscal cliff no longer on the distant horizon, the Congressional Budget Office (CBO) finds that altering certain aspects of the scheduled policy changes would boost GDP, while ignoring the cliff will swell the national debt in the coming years.
Affecting a number of government programs, the spending cuts and tax increases slated for January 1, 2013—also known as the fiscal cliff—will undoubtedly impact all sectors of the economy if an agreement is not met on how to deal with the upcoming policy changes.
Under current law with fiscal tightening carrying out as planned, GDP would drop by 0.5% in 2013. Output would be greater, however, if some areas of the scheduled changes were removed.
Focusing on the short-term, CBO presented an analysis with estimates of the budgetary and economic outcomes that would occur under an “alternative fiscal scenario.” The proposed scenario represents the continuation of many long-standing policies and a significant reduction in the amount of fiscal tightening scheduled for next year.
In the “alternative fiscal scenario,” CBO projects that the deficit under current law for fiscal year 2013 would total $641 billion. This scenario would also estimate $503 billion in budgetary costs for 2013 and $682 billion in 2014.
According to CBO, the individual components that must be eliminated to boost GDP include: automatic reductions in defense and non-defense spending, reductions in Medicare’s physician payment rates, extension of certain expiring tax cuts, indexation of the alternative minimum tax, extension of the payroll tax and emergency unemployment benefits.
Eliminating the first three changes would fall under CBO’s proposed “scenario” and would boost real GDP by about 2.25%, according to the report.
Eliminating all of the changes listed above would in turn boost real GDP for 2013 by about 3%.
Ignoring fiscal tightening altogether would cause a continued surge in federal debt for the remaining decade, whereas eliminating some of the tightening would put GDP well below its potential with unemployment reaching higher than usual numbers, according to CBO’s report.
There are drawbacks, however. If fiscal tightening occurs as it is supposed to under current law, an economic contraction marked by decline in the first half of the year and modest growth in the second half would cause the unemployment rates to rise by the end of 2013.
Written by Jason Oliva