The latest economic update from the Congressional Budget Office almost perfectly crystallizes the challenge before lawmakers: Cut the deficit or create jobs, but you’ll struggle to do both at the same time.
Navigating the fiscal cliff at the end of the year led the CBO to create two different scenarios about what the economy would look like next – which show how severe the tradeoff would be and whether we’d prefer to endure some economic pain now or later.
“The sharp increases in federal taxes and reductions in federal spending that, under current law, are scheduled to begin in calendar year 2013 are likely to interrupt the recent economic progress, resulting in what would probably be considered a recession,” CBO director Douglas Elmendorf blogged after the release of the report Wednesday morning.
Under the standard baseline scenario, all of the lower tax rates first introduced by President George W. Bush expire, Medicare payments to physicians are reduced, and the budget sequestration goes forward from last year’s compromise to raise the debt ceiling.
The deficit plunges next year to $641 billion in a $3.55 trillion budget. That’s almost $500 billion lower than the 2012 deficit. Outstanding federal debt held by the public – which doesn’t include intra-government holdings – drops from 73 percent of GDP to 58 percent a decade from now.
But the economy seizes up next year in a recession, the CBO projects. Gross Domestic Product falls outright by half a percentage point over 12 months and unemployment climbsing back above 9 percent. The unemployment rate would only approach its current level of 8.3 percent around the end of 2014.
It’s a glimpse into what would happen if negotiations between Republicans and Democrats at year end break down. In order to extend the lower tax rates only for Americans earning less than $250,000 a year, Sen. Patty Murray, D-Wash., has proclaimed that her fellow lawmakers are prepared to jump off the fiscal cliff.
The CBO’s “alternative” envisions a world where the White House – occupied by President Obama or Republican challenger Mitt Romney – assumes that the expiring tax provisions are continued indefinitely and a deal is brokered to sidestep the automatic spending cuts from sequestration. Those tax hikes for households earning more than $250,000 – a defining element of the Obama platform – never happen.
The deficit would stay above $1 trillion for a fifth straight year, and debt gets piled on to dangerous new highs.
But GDP would increase at 1.7 percent in 2013, an anemic pace but still better than the recession forecasted under the other scenario. And by the end of 2014, unemployment would fall to 7 percent, a level that would be reached two years later using the standard CBO baseline.
“Ultimately,” the CBO report concludes, “the policies assumed in the alternative fiscal scenario would lead to a level of federal debt that would be unsustainable from both a budgetary and an economic perspective.”