Congressional Budget Office Warns of Recession in 2013

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Director of the Congressional Budget Office Douglas Elmendorf. GettyThe nonpartisan Congressional Budget Office is warning that if $607 billion in tax increases and spending cuts all hit as scheduled -- roughly the beginning of next year -- the U.S. will likely go into recession in 2013.

This is the "fiscal cliff" you may have heard about. But while economists, the Federal Reserve, and members of Congress have been warning about its approach for some time, the CBO's report is the first detailed analysis of its potential effects.

A Recipe for Recession

All of the following are scheduled to occur around the turn of the year, and together make up the so-called fiscal cliff:

  1. The expiration of the Bush-era tax cuts, including a 3% to 5% upward income-tax adjustment and a 5% increase in the capital-gains tax.
  2. A return of the alternative minimum tax, which could affect those with yearly incomes as low as $30,000.
  3. A 2% payroll tax increase, which had temporarily been cut for 2011 and 2012.
  4. $1.2 trillion in automatic budget cuts, because the president and Congress failed to pass a deficit-cutting package in the wake of last summer's debt-ceiling debate.

While we're on the subject, the debt ceiling is due to be raised again in early 2013, prompting fears of another credit-rating damaging battle between the White House and Congress.

Each of these events happening in turn would likely have some negative impact on our struggling economy. But it's all of them happening at basically the same time that has the CBO so concerned.

Doom and Gloom? Yes and No

According to the CBO, if nothing is done to stop or alleviate these "fiscal restraints," the economy is "expected to contract by an annual rate of 1.3% in the first half of next year." But the silver lining in taking these economic hits all at once is a reduction in the federal deficit of 5.1% in calendar years 2012 and 2013, and a reduction in the federal budget of $560 billion for fiscal years 2012 and 2013.

Conversely, if Congress and the president agree to extend all the tax cuts and not cut any spending, the U.S. economy could grow at a robust 4.4% next year. To do so, however, would come with continued growth of the national debt. The CBO calls this "unsustainable" over the long term, adding that "policy changes would be required at some point."



We Can Do This the Hard Way, or the Hard Way

The public debt is currently around 70% of GDP -- getting up into eurozone crisis levels, but without a hint yet of eurozone-level panic. For that, we can thank the fact that the U.S. dollar is still the world's reserve currency and Treasuries are still seen as the ultimate safe haven, which keeps yields low. This has shielded us from the ruthless vagaries of the sovereign bond market, which is currently giving the eurozone such a hard time.

Right now, Republicans want to renew the Bush-era tax cuts. Democrats want to let them expire, except for those with annual salaries of less than $250,000. Neither side wants the $1.2 trillion in automatic budget cuts to hit, but Republicans especially -- as a well-funded military is part of their political bread and butter.

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Likewise, the Democratic party probably doesn't want a return of the alternative minimum tax, because the less-well-off, which the tax would hit hardest, have always been a greater part of its constituency. The payroll tax cut was championed by President Obama, but the rationale for it -- an economy in recession -- is gone.

And neither side ought to want another high-stakes, high-profile debt-ceiling debate. Last summer, it cost the country its coveted AAA credit rating. But depending on who's sitting in the oval office come 2013 and what parties come out ahead in the House and Senate, it may not even be an issue.

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Congressional Budget Office Warns of Recession in 2013

With a national debt still hovering around 120% of its GDP, Greece is still far from being out of the fiscal woods. As austerity measures bite, Greece's GDP will shrink further and its debt-to-GDP ratio will rise, putting it on course for further defaults -- er, "restructurings." Nor is Greece alone. According to official figures, debt-to-GDP ratios elsewhere are similarly high.

Photo: Gerasimos, an 83-year-old Greek man, picks through a heap of rubbish to salvage useful items as the marble gate of the Roman Agora is reflected in a mirror, in the Plaka district of Athens on Monday, March 12, 2012. Greece implemented the biggest debt writedown in history on Monday, swapping the bulk of its privately-held bonds with new ones worth less than half their original value. (AP Photo/Petros Giannakouris)

Debt-to-GDP ratio: 130%

Photo: President of Iceland Ólafur Ragnar Grímsson prior to voting in a referendum in Reykjavik, Iceland, Saturday, March 6, 2010.   Icelanders voted "no" in a nationwide referendum on approving the use of $5.3 billion of taxpayers' money to repay international debts.  The "no" vote may complicate Iceland's effort to recover from a deep recession and a banking collapse. (AP Photo/Brynjar Gauti)

Debt-to-GDP ratio: 120%

Photo: A man reads a newspaper in Milan, Italy, Monday, Jan. 30, 2012. European leaders are trying to come up with ways to boost economic growth and jobs, which are being squeezed by their own governments' steep budget cuts across the continent. The 27 EU leaders meeting in Brussels are also looking for common ground on a new treaty to toughen spending rules to dig the continent out of a crippling debt crisis. (AP Photo/Luca Bruno)

Debt-to-GDP ratio: 110%

Photo: Workers seen at the Luis Onofreâ luxury shoe factory in Oliveira de Azemeis, Portugal, Friday, Feb. 24, 2012. Debt burdens are rising fastest in European countries that have enacted the most draconian austerity programs. Portugal's unemployment rate hit a record 14 percent at the end of last year and the government imposed austerity measures to slash costs: Portugal cut pensions, reduced public servants' wages and raised taxes starting in 2010. (AP Photo/Paulo Duarte)

Debt-to-GDP ratio: 105%

Photo: People walk past a beggar on a bridge in Dublin Monday Feb. 20, 2012. Bank of Ireland, the only one of Ireland's six banks to avoid nationalization, reported it returned to net profit in 2011 thanks to heavy debt restructuring in the face of continued losses from dud loans. (AP Photo/Shawn Pogatchnik)

Debt-to-GDP ratio: 102%

Photo: The shadow of Republican presidential candidate, former Massachusetts Gov. Mitt Romney, is seen on a representation of the National Debt Clock as he spoke at a town hall meeting in Kalamazoo, Mich., Friday, Feb. 24, 2012. (AP Photo/Gerald Herbert)

Debt-to-GDP ratio: 85% each

Photo: Reflected in a window, people walk in London's City financial district, Tuesday, Feb. 14, 2012. Britain's AAA credit rating was put on a "negative outlook" by ratings agency Moody's, amid fears over weaker growth prospects and potential shocks from the eurozone crisis. Britain's Chancellor George Osborne said the assessment was a vindication of the Government's tough austerity measures and "a reality check for anyone who thinks Britain can duck confronting its debts". Moody's downgraded the ratings of six countries and also put France and Austria on the same caution as the UK amid violent protests in Greece. (AP Photo/Lefteris Pitarakis)

Debt-to-GDP ratio: 82%

It makes you wonder: Who will be next in line to default? And when they do, will we call that "good news," too?

Photo: A pedestrian looks at a sign in a shop reading: ''One euro, price haircut'' in Athens on Thursday, March 8, 2012. (AP Photo/Thanassis Stavrakis)

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So the U.S. can take its licks now or later, but it will have to take them at some point along the way. The most sane and least painful way to do it would be to find middle ground between the two policy extremes outlined above -- one that would allow for a slower winding down of debt that keeps growth at a reasonable level, something the CBO also suggests.

The point is, there's clearly room in the coming fiscal-cliff showdown for maneuver, negotiation, and face-saving on both sides. Let's hope it's taken advantage of.

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