The current tax increases and spending cuts slated to go into effect January 2013 will likely lead to a recession, a new Congressional Budget Office (CBO) report says. On the other hand, preventing those policies from going into effect without replacing them with something comparable would lead to unsustainable amounts of public debt.
If the tax increases and spending cuts are allowed to occur, the CBO estimates that the economy will shrink 1.3 percent in the first half of 2013, followed by a meager 2.3 percent growth in the second half of 2013.
On the plus side, the additional revenue and lower spending will cut deficit spending by $560 billion, almost half of the projected $1.2 trillion 2012 deficit.
While abandoning the planned spending cuts and tax increases would prevent a recession in 2013, the CBO warns that it would harm the economy in the long term.
"However, eliminating or reducing the fiscal restraint scheduled to occur next year – without imposing comparable restraint in future years – would reduce output and income in the longer run relative to what would occur if the scheduled fiscal restraint remained in place [emphasis in original]," CBO wrote.
The longer that Congress and the president wait to tackle the debt crisis, CBO warns, "the greater would be the negative consequences – for the nation's future output and income, for the burden imposed by interest payments on the federal debt, for policymakers' ability to use tax and spending policies to respond to unexpected challenges, and for the likelihood of a sudden fiscal crisis."
The tax increases, dubbed "taxmageddon," were originally from tax cuts that went into effect during the George W. Bush administration but were set to expire. The original expiration date was 2010, but President Obama and Congress extended those tax cuts for another two years.
The spending cuts are from the Budget Control Act of 2011. As part of a negotiation to raise the nation's debt limit, Congress set up a bipartisan "super committee" to craft a bill that would reduce deficits by $1.2 trillion over the next 10 years. The super committee failed, which means that $1.2 trillion dollars of automatic spending cuts, mostly in defense spending, will go into effect without further changes.
The federal government is also expected to reach its debt limit near the end of 2012 or early 2013. Speaker of the House John Boehner (R-Ohio) has recently said that he would not support an increase to the debt limit without spending cuts equal to or greater than the amount of the debt limit increase. He also said that he hopes a showdown over the debt limit increase will lead Congress to enact a "grand bargain" that would reform entitlements and the tax code while reducing long-term budget deficits.
Senate Majority Leader Harry Reid (D-Nev.) wrote to Republicans Tuesday that he would not consider any legislation to reform entitlements and taxes before the November election due to "Tea Party extremism."