Recession Looms if Congress Allows Economy to Go Over ‘Fiscal Cliff,’ CBO Warns

By Matt Cover | May 24, 2012 | 7:18 PM EDT

ype="node" title="CBO logo

( – The U.S. economy will likely slip into recession next year if Congress does not do something to avoid the massive tax increases and spending cuts scheduled to happen at the end of the this year, according to the Congressional Budget Office (CBO).

If Congress allows the combination of tax hikes and spending cuts to take effect, CBO forecasts that the economy will shrink significantly over the first half of 2013, sending the country into a recession.

“[G]rowth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5 percent, CBO expects – with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half,” the CBO wrote in a May 22 report.

Since a recession occurs when the economy shrinks for two consecutive quarters – six months – by foreseeing a 1.3 percent contraction in the first six months of 2013, CBO is predicting that the economy will fall back into recession.

At the end of 2012 a combination of expiring tax rates, including the Bush tax cuts, and automatic spending cuts passed last year will drastically reduce the federal deficit, harming the economy and increasing unemployment.

“Taken together, CBO estimates, those policies will reduce the federal budget deficit by $607 billion, or 4.0 percent of gross domestic product (GDP), between fiscal years 2012 and 2013,” CBO said. “The resulting weakening of the economy will lower taxable incomes and raise unemployment, generating a reduction in tax revenues and an increase in spending on such items as unemployment insurance.”

The economy will go into recession because the combination of tax increases and large spending cuts will cause household spending to drop and will decrease demand in the economy, CBO said.

“The increases in taxes and decreases in government benefits will lead households to cut back their purchases of goods and services, and the decline in funding for government programs will lead to further cuts in purchases.”

This drop in consumer demand will lead businesses to cut back on their purchasing and investments, and force them to cut jobs.

The resulting recession will probably resemble shallow recessions of the past.

“The economic outcomes that CBO expects, under current law, for the first half of 2013 strongly resemble mild recessions that occurred in the past,” CBO said.

CBO also found that if Congress does act to prevent the government from going over this so-called “fiscal cliff,” the economy could begin to grow much more strongly than it currently is.

“In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, well above the 0.5 percent projected for 2013 under current law.”

However, CBO also said that if Congress simply avoids the fiscal cliff – extending lower tax rates and higher spending – it would harm the economy in the long term, increasing federal borrowing and crowding out private investment and reducing savings.

“If all current policies were extended, debt would be substantially higher,” CBO explained. “Rising debt would cause a growing portion of people’s savings to go to purchase government debt rather than to finance investments in productive capital, such as factories and computers.”