CBO Says Fiscal Cliff Looms, but Decisions Not Likely Till Precipice Appears

Reactions to CBO report by Republicans and Democrats suggest grand compromise before election unlikely

Can John Boehner and President Obama reach a Grand Bargain—again—before the end of the year? (Photo: AP) Can John Boehner and President Obama reach a Grand Bargain—again—before the end of the year? (Photo: AP)

The Congressional Budget Office is warning of a “fiscal cliff” looming at year end, when Bush-era tax cuts expire just as automatic spending cuts take effect in the new year, but lawmakers are signalling that prompt action on the crisis is unlikely.

The dual deficit-cutting measures would arrest America’s long-term debt accumulation but also withdraw crucial support for a still weak economy, pushing the U.S. back into recession in the first half of fiscal 2013, the CBO warns.

Republican presidential candidate Mitt Romney commented on the fiscal cliff scenario in an interview with Time Magazine on Wednesday, saying if elected he hoped he would be given a “grace period” within which to deal with America’s fiscal problems “on a structural basis” rather than see a lame-duck Congress and President handle the issue.

Senate Majority Leader Harry Reid (D-Nev.), for his part, said a grand compromise by Congress prior to the year-end lame-duck session was unlikely as a result of what he called Republicans’ “blind adherence to Tea Party extremism.” His colleague Jeff Sessions, the ranking Republican on the Senate Budget Committee, shared Reid's scheduling outlook, saying “It looks like there will not be a vote until after the election.”

While Romney would like to decide fiscal policy in the new year (if elected) and leading Democrats and Republicans say it should be decided now if the other side would only be more reasonable, the window for decision-making may likely be the short congressional session following November elections and before lawmakers recess for Christmas.

And the CBO’s recent report, released Tuesday, makes the point that if Congress cannot find some way to arrest policies that are already set in motion before the new year — and the need to do so speedily was emphasized — the short-term result will be reduced incomes, higher unemployment, weak tax revenues and increased unemployment insurance costs.

The CBO also acknowledges that extending current policies — that is, maintaining the Bush tax cuts and withholding $1 trillion in spending cuts scheduled for the new year — would lead to fiscal ruin in the long term but would facilitate GDP growth of 4.4% in fiscal 2013 (and a higher still 5.3% for the first half of 2013).

To avoid the drag on a weak economy on the one hand and fiscal ruin on the other, the CBO proposes a Goldilocks, middle-bear approach: “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,” CBO analyst Benjamin Page writes.

“The longer the U.S. delays righting its fiscal course “the more drastic the ultimate changes in policy would need to be,” the report continues.

The report’s middle option would involve “changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period.”

Doing so “soon,” even “quickly,” the report concludes, “would tend to boost output and employment in the next few years by holding down interest rates and by reducing uncertainty and enhancing business and consumer confidence.”

But, in what is perhaps the hardest part of the CBO report to grasp in today’s heated political atmosphere, the report says its middle approach “would work best if the future policy changes were sufficiently specific and widely supported.” By apparently kicking this fiscal can to the end of the year, just as the American people are staring down the fiscal cliff, the opportunity to build “wide support” will have to occur, if it does, in an expedited manner come November.

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Check out more CBO-related stories on AdvisorOne.

Read CBO Projects $1.1 Trillion Budget Deficit for 2012 if Laws Don’t Change on AdvisorOne.

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