If Congress fails to act and America goes over the fiscal cliff on Jan. 1, 2013, the U.S. economy will, as many have noted, quickly slip into a recession.
But if Congress does somehow agree to avert all or most of the impact of the fiscal cliff, it simply postpones the pain for a few months or years.
And if Congress elects to postpone the fiscal cliff indefinitely, choosing to continue the federal government's massive deficit spending in perpetuity, the federal debt will weigh more and more heavily on U.S. economic growth as the years go on.
"That highlights lawmakers' dilemma," wrote The Wall Street Journal in a recent editorial. "Going off the cliff will produce great pain in 2013 but lead to a more stable fiscal situation a decade on. Averting it will forestall recession now but hamstring growth later."
How Fiscal Cliff 2013 Affects U.S. Economy The fiscal cliff is political shorthand for the combination of spending cuts and tax increases scheduled to hit Jan. 1, 2013. It's the result of the expiration of the President Bush-era tax cuts combined with $1.2 trillion in automatic reductions in federal spending made last summer as part of the deal to raise the debt ceiling.
The consequences of going over the fiscal cliff or delaying it can be found in the latest report on the matter from the Congressional Budget Office (CBO), "Economic Effects of Policies Contributing to Fiscal Tightening in 2013."
And this latest report, which is different than the previous CBO projections, actually includes a clue as to how Congress could decide to deal with the fiscal cliff before the end of the year...
That's because the recent report was done at the request of Senate Finance Committee Chairman Max Baucus, D-MT, specifically to study what would happen if Congress pushed the fiscal cliff two years into the future.
The CBO has previously offered stark predictions about the fiscal cliff impact on GDP (gross domestic product) if Congress does nothing.
The CBO, in previous reports, said if the U.S. economy "fell off" the fiscal cliff, GDP would shrink by 1.3% in the first half of 2013 and 0.5% for the full year, pushing the country back into recession. Unemployment would again start rising, reaching 9.1% by the end of 2013.
But as bad as things would be for much of 2013, the U.S. economy would begin recovering before the year was over.
In the "fall off" scenario, GDP turns the corner in the second half of 2013, rising 2.3%. Then, in 2014, GDP jumps 5%, followed by a startling 6.4% increase in 2015.
And the country's debt burden would start to fall from 70% of GDP now to 61% in 2022 and 53% in 2037.
So in exchange for short-term financial pain the U.S. economy would gain a long-term benefit by finally getting the government's deficit spending under control.
But as the current report shows, a two-year extension of current policies will also deliver an economic blow, just a delayed one.
U.S. Economy at Risk Regardless Given the panicky predictions for what awaits America if it goes off the fiscal cliff, it's no wonder that avoiding it is considered the most desirable option.
But in the long term, avoiding the fiscal cliff is akin to avoiding the dentist when you have a toothache. The pain will just keep getting worse.
Or as the CBO puts it: "Debt cannot continually increase as a share of the economy: Policy changes would be required at some point. The longer the necessary adjustments in policies were delayed, and the more that debt increased, the greater would be the negative consequences."
Extending current policies would indeed push GDP up 5.3% in the first half of 2013, which sure sounds a lot better than another recession.
But the initial growth spurred by extending current policies starts to peter out after six months. By the second half of 2013, the CBO says GDP would slow to 3.4%. From there, slower growth would continue through 2016.
Most troubling, however, is what happens to the federal debt - currently over $16 trillion and accumulating at a rate of over $1trillion per year.
Avoiding the fiscal cliff ensures that federal debt held by the public will rise to more than 90% of GDP by 2022, pass its historical high of 109% by 2027 and soar to nearly 200% by 2037.
Countries with public debt levels over 100% - like Greece (165%), Italy (120%) and Japan (205%) - tend to have major economic problems.
In fact, the CBO predicts the ballooning federal debt will start eating away at U.S. economic growth at a faster and faster rate - a 1.8% reduction in GDP by 2027 and a 6.7% reduction by 2037.
"Large budget deficits would reduce national savings, thereby curtailing investment in productive capital and diminishing future output and income," the CBO report said.
These CBO projections leave Congress with a greater dilemma than many realize. Lawmakers need to do more than just avoid the fiscal cliff - they need to deal with it in a way that won't plunge the U.S. economy in to recession now, and won't stifle growth later.
Ideally, Congress would cobble together a "grand bargain" that strikes just the right balance, but given the deep partisan divide on Capitol Hill it's more likely they'll kick most of the problem down the road - again.
"They'll do enough to get us through this crisis," Greg Valliere, chief political strategist at Potomac Research Group, said in remarks yesterday (Wednesday) at the Charles Schwab Impact 2012 conference in Chicago. "We'll probably have to visit these issues again and again."
Related Articles and News:
- Money Morning:
The Fiscal Cliff is a Mole Hill Compared to This
- Money Morning:
Fiscal Cliff Not a Priority for This Do-Nothing Congress
- Money Morning:
Will the Fiscal Cliff Clash Damage the U.S. Credit Rating?
- CIA World Factbook:
Country Comparison, Public Debt
'Fiscal Cliff' Only the Beginning: Valliere
Long-term Budget Outlook 2012
Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013
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