The CBO’s latest report on the economic effects of the fiscal cliff amount to a lose-lose situation. If the currently scheduled tax breaks are allowed to expire, the economy worsens and unemployment increases. If the tax breaks are allowed to continue, the debt situation approaches crisis stage quickly. This leaves the United States between a rock and a hard place, regardless of the path chosen. Here is a summary of the report. 

The CBO Report  

The Congressional Budget Office report on the economic impact of the fiscal cliff is entitled "Economic Effects of Policies Contribution to Fiscal Tightening in 2013." 

The full report can be obtained at: http://www.cbo.gov/publication/43694

The full report goes into great length about the economic impact. We have summarized their conclusions below, mostly using tables. 

Summary Of Impact On GDP Growth 

The first calculations of the CBO report  are based upon projections of GDP growth, if the tax cuts that are expected to expire at the end of the year are extended. 

The CBO calculates the expected 2013 GDP growth that will result in a variety of scenarios, which we have summarized in the list below. 

• Eliminate the sequestration spending cuts scheduled for 2013: +3/4 percent GDP
• Extending all expiring, except payroll tax and indexing AMT: + 1.5 percent GDP
• Extend all expiring tax cuts, except individuals with income above $250,000: +1.25 percent GDP 
• Extend payroll tax cut and unemployment benefits: +3/4 percent GDP 

These calculations are cumulative, so that if all of the expiring tax cuts listed above were extended, GDP growth could be expected to be 300 basis points higher than would otherwise occur. 

The CBO has explicitly stated that they do not expect the payroll tax or unemployment benefits extension to be enacted, however, although not in this particular report. 

This means that GDP growth could be enhanced by 2.25% if the expiring tax cuts were extended. 

This expected GDP growth would be 2.0% if the expiring tax cuts were extended, except for persons earning more than $250,000. 

The Alternative Fiscal Scenario 

The CBO does not make any predictions as to the likelihood of Congressional action. 

However, the CBO did create an “alternative fiscal scenario,” which is defined as follows: 

• Extension of the expiring tax cuts, except the payroll tax, and index the AMT
• Elimination of the sequestration spending cuts in the DOD
• Elimination of spending cuts in non-DOD discretionary spending 

This scenario allows for a more readily digestible analysis of the impact of the fiscal cliff. 

Employment Growth

The CBO also calculates the increased employment that would be generated if the expiring tax cuts were extended. 

The full report provides employment data for each individual aspect of the fiscal cliff. 

For brevity, we provide just the total calculation for the alternative fiscal scenario.

If all three of the steps in the alternative scenario were taken, the CBO estimates that 2.7 million additional new jobs would be created by the end of 2013. 

The Cost Of The Fiscal Cliff 

The projected growth in GDP and employment comes at a cost to the deficit, however. 

The following table calculates the expected increase in the deficit – from current levels – if various aspects of the fiscal cliff expirations were extended. 

As shown in the table, the growth in the GDP expected from allowing expiring aspects of the fiscal cliff to continue is quite high. 

Note that the above estimates are not estimates of the total deficit. They are estimates of the additional cost of the deficit already forecast by the CBO in their baseline projection for 2013 and 2014. 

It should also be noted that the impact on the deficit of increasing taxes on incomes above $250,000 is estimated at just $42 billion in 2013. 

This is approximately 4% of all income taxes collected. In other words, it is a rather minimal aspect of the overall fiscal environment. 

Summary Of The Report

The following list summarizes the impact of the alternative fiscal scenario, as calculated by the CBO. 

• Growth in GDP in 2013: 2.25% 
• Growth in Emploment in 2013: 2.7 million jobs
• Cost In Deficit in 2013:
• Cost In Deficit in 2014: 

This, in a nutshell, is the economic impact of extending the expiring tax cuts, except for the payroll tax, indexing the AMT for inflation, and eliminating all of the sequestration spending cuts mandated by the Budget Control Act of 2011. 

Conclusion

A careful reading of the CBO report summarizes the US budgetary position bluntly: we are between a rock and a hard place. 

Enacting fiscal discipline will hurt GDP growth and employment. 

Extending the expiring tax cuts and eliminating sequestration cuts will increase the deficit significantly. 

There is simply no two ways about it. 

What path will Congress and the President choose? 

Your guess is as good as ours. 

But if past history is any indication, the government will choose to again postpone serious attempts to deal with the deficit, and instead choose short term growth over long term financial health. 

Such a path cannot last forever, but the calculations made by the CBO are likely to be used to argue for the extension of the expiring tax cuts.

There is likely, however, to be a great deal of arguing over whether persons with incomes over $250,000 should have their taxes increased. 

This is likely to be true, even though the economic impact is only 0.25 percent of GDP and 200,000 less jobs. In the grand scheme of things, the numerical differences are almost trivial. 

The full report examines each of the various aspects of the fiscal cliff individually. The report also spends a fair amount of time explaining the rationale and logic behind the calculations. 

What we have provided above is a summary of the most critical data points. 

Comments may be emailed to the author, Robert V. Green, at aheadofthecurve@briefing.com