CBO Rappels Down Fiscal Cliff, Gets Scared

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By Deborah Solomon

Maybe Washington's paralysis is understandable.

A report by the nonpartisan Congressional Budget Office underscores the damned-if-you-do, damned-if-you-don't choice facing policymakers who must decide how to deal with a tsunami of tax increases and spending cuts -- also known as the fiscal cliff -- scheduled to crash down at the end of this year.

Do nothing and the crushing federal budget deficit drops significantly but the U.S. economy probably falls back into recession next year. Do too much and the U.S. economy sputters over the long-term.

Here's the problem: A host of tax provisions lowering income and payroll taxes and limiting the reach of the Alternative Minimum Tax are set to expire. At the same time, more than $65 billion in spending cuts required under the 2011 Budget Control Act are set to kick in.

In theory this is good news: CBO projects that allowing these policy changes to occur would reduce the federal deficit by $607 billion, or 4 percent of gross domestic product, between 2012 and 2013. The flip side is the combination of tax increases and spending cuts will do more than prompt palpitations in Keynesians, it will slow economic growth to the anemic level of just 0.5 percent. CBO projects the economy will contract at an annual rate of 1.3 percent in the first half of 2013 and 2.3 percent in the second half -- levels likely to be judged recessionary.

OK, you say, get those wily lawmakers to renew the tax cuts and boost spending. That would help -- for a little while. CBO estimates removing or offsetting the fiscal cliff would boost GDP growth by about 4.4 percent versus 0.5 percent.

But imposing no fiscal restraint would ultimately hurt the economy more than taking no action in the short run, since federal debt, which is already 70 percent of GDP, would rise much faster than economic growth. "Large budget deficits would reduce national saving, thereby curtailing investment in productive capital and diminishing future output and income. Interest payments on the debt would consume a growing share of the federal budget, eventually requiring either higher taxes or a reduction in government benefits and services."

Oh and all this irresponsibility would likely trigger a fiscal crisis, in which investors lose confidence in the U.S., sending borrowing costs skyrocketing.

So what's the answer? Allowing for bigger deficits in the short-term while imposing restraint down the road would give the economy breathing room and allow the U.S. to get itself on a sustainable fiscal path. One can only hope the threat of another recession is enough to shake off Washington's paralysis and usher in sensible policy choices that will protect the economy long after today's lawmakers have left town.

(Deborah Solomon is a member of the Bloomberg View editorial board. Follow her on Twitter.)


-0- May/22/2012 21:44 GMT