CBO Report: Fiscal Tightening in 2013 and Its Economic Consequences

Via Congressional Budget Office:

Under current law, a sharp reduction in the federal budget deficit between 2012 and 2013 will cause the economy to contract, the Congressional Budget Off ice projects, but will also put federal debt on a path more likely to be sustainable over time. To illustrate the eff ects of fiscal tightening, CBO compared its projections under current law (the "baseline" projections) with projections under an alternative set of policies — two scenarios in a broad spectrum of choices. (see chart)

In order to focus on the short-term impact of policy decisions, the analysis in this report is based on the assumption that the fiscal tightening would be removed and current policies maintained for two years and that the tightening provided by current law would occur thereafter. (In contrast, CBO’s August analysis of the alternative fiscal scenario was based on the assumption that those current policies would be maintained indefinitely.)

On the basis of its analysis, CBO concludes the following:

  • Eliminating the automatic enforcement procedures established by the Budget Control Act of 2011 that are scheduled to reduce both discretionary and mandatory spending starting in January and maintaining Medicare’s payment rates for physicians’ services at the current level would boost real GDP by about three-quarters of a percent by the end of 2013.
  • Extending all expiring tax provisions other than the cut in the payroll tax that has been in effect since January 2011—that is, extending the tax reductions originally enacted in 2001, 2003, and 2009 and extending all other expiring provisions, including those that expired at the end of 2011, except for the payroll tax cut—and indexing the alternative minimum tax (AMT) for inflation beginning in 2012 would boost real GDP by a little less than 1½ percent by the end of 2013.
  • Making all of the changes described in the two preceding bullets—which captures all of the policies included in the first two years of CBO’s alternative fiscal scenario—would boost real GDP by about 2¼ percent by the end of 2013 (as CBO estimated in August). Thus, of the total difference in the projected growth of GDP next year under current law and under the alternative fiscal scenario, about two-thirds owes to changes in tax policies and about one-third owes to changes in spending policies.

  • The estimated economic effect next year of those changes in spending is about half the estimated effect of extending the expiring tax provisions, even though the budgetary impact of the changes in spending is less than one-quarter of the impact of the changes in taxes. The larger “bang for the buck” next year of the spending policies under the alternative fiscal scenario occurs because, CBO expects, a significant part of the decrease in taxes (relative to those under current law) would be saved rather than spent.
  • Extending all expiring tax provisions other than the cut in the payroll tax and indexing the AMT for inflation—except for allowing the expiration of lower tax rates on income above $250,000 for couples and $200,000 for single taxpayers—would boost real GDP by about 1¼ percent by the end of 2013. That effect is nearly as large as the effect of making all of those changes in law and extending the lower tax rates on higher incomes as well (which CBO estimates to be a little less than 1½ percent, as noted above), primarily because the budgetary impact would be nearly as large (and secondarily because the extension of lower tax rates on higher incomes would have a relatively small effect on output per dollar of budgetary cost).
  • Extending both the current 2 percentage-point cut in the payroll tax and emergency unemployment benefits—extensions that are not assumed in the alternative fiscal scenario—would boost real GDP by about three-quarters of a percent by the end of 2013. Making those changes along with making all of the changes in CBO’s alternative fiscal scenario would boost real GDP by about 3 percent by the end of 2013.

You can read the sixteen page report here.

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