CBO: Fiscal Cliff Deal Averted Recession But Sequester Could Cause Severe Economic Pain

January 8, 2013 - 5:59 PM

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(AP Photo)

(CNSNews.com) – The Congressional Budget Office (CBO) said the fiscal cliff deal reached between Congress and the Obama administration avoided the recession that the agency anticipated would occur at the beginning of this year absent a deal, but the agency also noted that the sequester (automatic spending cuts) could reduce GDP projections and cause significant economic pain.

The report, which the CBO released on Friday, answers a number of questions about the fiscal cliff deal, including what projected impact it will have on the economy in 2013.

“We and many other forecasters had warned that, if all of the fiscal tightening that was scheduled to occur at the end of 2012 had actually occurred, the economy probably would have fallen into a recession,” the CBO reported.

The CBO said that now that Congress had avoided most of the tax increases included in the fiscal cliff, the economy would grow by 1.5 to 1.75 percentage points more than it otherwise would have, avoiding the recession forecast for the first half of 2013.

“[T]he legislation will probably increase GDP growth in 2013 by about 1.5 to 1.75 percentage points relative to what would have happened under prior law,” stated the CBO.

GDP, or Gross Domestic Product, is the total estimated value of all goods and services produced in the United States during one year, which currently is $15.9 trillion.  (See table 9.)

The agency had forecast a mild recession for the first half of 2013, resulting in a 0.5 percent reduction in GDP, if no action had been taken to address the fiscal cliff.

“According to CBO’s projections, if all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5 percent in 2013,” the CBO said in November, “reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year.”

Technically, a recession is when GDP shrinks for two consecutive quarters – six months, in other words.

The National Bureau of Economic Research (NBER) -- the definitive determiner of when recessions begin and end -- declared that the last recession ended in June 2009.

Still, CBO said that the automatic spending cuts – known as the sequester – could still occur, since Congress merely delayed them until March as part of the fiscal cliff deal.

Those spending cuts could still have a damaging effect on the economy, though one that is potentially short of a recession. CBO did not say whether the economic pain from the sequester and the tax increases that Congress allowed to occur would result in a small recession later in the year.

John Boehner, Barack Obama

Speaker John Boehner (R-Ohio) and President Barack Obama. (AP Photo)

The CBO said that the automatic spending cuts that are still to come and the tax increases that did take place could combine to reduce economic growth by about 1.25 percentage points in 2013.

“Although the recent legislation reduced the magnitude of fiscal tightening by 1.5 to 1.75 percentage points relative to prior law, our November report identified other components of tightening that are still in place and that we estimated will damp GDP growth in 2013 by roughly 1.25 percentage point[s].”

The fiscal cliff deal made permanent most of the Bush-era tax rates as well as permanently indexing the Alternative Minimum Tax for inflation, as well as staving off Medicare cuts for doctors for one more year. The payroll tax rate (tax for Social Security) is increasing from 4.2 percent to 6.2 percent.

The deal also delayed until March the spending cuts known as the sequester, which impose across-the-board spending cuts to discretionary federal spending and did not extend Bush-era tax rates for those making $450,000 per year or more. Those tax rates rose to Clinton-era levels as planned per the 2010 compromise between Congress and the Whitehouse, when the original Bush package of tax cuts expired.