Fiscal Cliff Will Cause Recession, CBO Warns

Massive spending cuts and tax hikes could cause more damage than previously thought if Washington fails to come up with a solution, according to a Congress budget referee. Without a solution, the "fiscal cliff" could cause the GDP to shrink .5 percent in 2013.

By: Reuters
Published: Wednesday, 22 Aug 2012

Massive spending cuts and tax hikes due next year will cause even worse economic damage than previously thought if Washington fails to come up with a solution, Congress' budget referee warned on Wednesday.

The Congressional Budget Office said failure to avoid the so-called "fiscal cliff" of expiring tax cuts and automatic spending reductions would cause the gross domestic product to shrink 0.5 percent in 2013. Previously, the nonpartisan CBO forecast full-year GDP growth of 0.5 percent.

The first half of 2013 will be particularly difficult, the CBO said in its mid-year forecast update. Tax hikes and spending cuts will cause GDP to shrink 2.9 percent in the first half, compared with a prediction in May for a 1.9 percent contraction.

There will still be a slight bounceback in the second half of 2013, but it will be weaker, with growth of only 1.9 percent, compared with a previous forecast of 2.3 percent growth.

The main reason for the gloomier outlook is that the fiscal cliff is steeper than previously estimated because of extensions earlier this year of a payroll tax cut and federal unemployment benefits, the CBO said.

It also said the general global and U.S. economic outlooks have dimmed since its last report, another factor weighing on its projections.

For the current fiscal year, which ends Sept. 30, the agency shaved its U.S. budget deficit forecast to $1.128 trillion from $1.171 trillion, mostly due to lower-than-expected spending for Medicare and Medicaid.

In fiscal 2013, assuming that scheduled tax hikes and spending cuts take effect, the CBO said the deficit would shrink dramatically to $641 billion. This is slightly higher than its previous forecast of $612 billion because of lower revenue and higher spending assumptions.

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