CBO issues another “fiscal cliff” warning

Back in May, the Congressional Budget Office (CBO) issued a stark warning to Congress that tax hikes scheduled to happen at the beginning of the year could trigger another recession. Since that time President Barack Obama and Senate Democrats have refused to act on extension of all current tax rates, which is the position of House Republicans. Instead, they’ve only pushed for one-year extension for individuals making $200,000 and families bringing in $250,000.

But yesterday, the CBO once again stressed that the looming tax hikes could hurt the economy if the stalemate doesn’t end:

In a fresh warning about the so-called “fiscal cliff,” the nonpartisan CBO reiterated that the U.S. economy will go into a recession next year if the Bush-era tax cuts expire and automatic spending cuts take effect. Read the CBO report.

In its latest report, the CBO predicts that the U.S. economy will grow at a 2.1% clip in 2012, but fall by 0.5% between the fourth quarter of 2012 and the fourth quarter of 2013 under the fiscal cliff scenario.

Previously, the CBO said growth would be 0.5% in 2013 under the fiscal cliff. In its new report it said the “underlying strength” of the economy is weaker.
The CBO said unemployment would jump to around 9% in the second half of 2013 from its current 8.3% if the tax increases and spending cuts play out.

Other studies have noted that the tax hikes scheduled to take place could cause the economy to contract between 1.3% to 2.9% and cost more than 700,000 jobs. Unfortunately, Obama is, according to Treasury Secretary Tim Geither, “absolutely committed” to raise taxes on higher-income earners, despite the fact that the top 20% of taxpayers already pay 69.1% of all income taxes.

Raising taxes in a still shaky economy is an idea even most Keynesians will dismiss. Christina Romer, who served as an economic adviser to President Obama, noted prior to her job in the White House that tax hikes hurt the economy:

In a study she and her husband, David Romer, conducted before she joined the administration, Ms. Romer found large multipliers from tax cuts, which she concluded “have very large and persistent positive output effects.” Tax increases, she also found, hurt growth.

As far as the scheduled spending cuts go, there is empirical evidence that reducing government outlays spur economic growth, not the other way around. Maintaining the current rate of spending is clearly unsustainable, but if some deal just happens to be struck in Congress, we’ll be right back where we were with a debt crisis in a few years or perhaps even sooner.

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