The Congressional Budget Office(CBO) has just issued a report showing that if an agreement is not reached to avoid the fiscal cliff, the U.S. economy could drift back into a recession and the jobless rate could rise to over 9 percent by the end of 2013.
The CBO predicts that if Congress fails to make a deal to avert the fiscal cliff that economic output would drop by 0.5% in 2013. The fiscal cliff refers to the effect of a series of enacted legislation which, if unchanged, will result in tax increases, spending cuts, and a corresponding reduction in the budget deficit in the beginning of 2013. However, in the longer run the CBO predicted better growth rates and lower unemployment.
The CBO had forecast previously that the U.S. could fall into recession in 2013 if the fiscal cliff is not avoided. However, any deal will no doubt drive up the U.S. deficit.The CBO predicted a deal would increase the budget deficit by $503 billion in 2013 and $682 billion in 2014. The CBO also claimed that avoiding the $55 billion scheduled in defense cuts would add 400,000 jobs in the fourth quarter of 2013. However, similar effects could be achieved by avoiding cuts to other domestic spending!
Keeping tax cuts set to expire and not extending the scope of the minimum tax would also boost GDP and generate 1.8 million jobs. If taxes were increased just on wealthier Americans, this still increases GDP and creates 1.6 million new jobs.
This is a graph of U.S. gross federal government debt from 1981 to 2012 (est), as a percentage of GDP, color coded by congressional control and highlighting presidential terms. The data is from the U.S. Office of Management and Budget
If Congress takes no action taxes will increase on Jan.1 2013. $110 billion in federal spending cuts will automatically kick in. Under the deficit deal, this is just a down payment on the $1 trillion spending cuts required over the next decade in last year's deficit deal. Negotiations will need to begin soon to reach a compromise before the end of this year.
During the last two days since the Obama election, U.S. stocks have suffered heavy losses. While one might think that the fact that there was a clear winner would cause the market to trend upward since markets dislike uncertainty, the looming fiscal cliff seems to be making investors nervous. The markets had actually been doing well earlier. Investors are concerned that negotiations for a deal to avoid the fiscal cliff may not go well. In the past Republicans and Democrats have found reaching a compromise difficult--as was the case in extending the debt ceiling.
If no deal is reached, investors worry that the U.S. will fall back into recession. Europe's continuing economic troubles also are a factor in the stock declines. It is quite possible that the lame duck congress may work out a temporary fix to buy time and leave much of the work to the new Congress in the new year.