The CBO and Our Fiscal Cliff

The Congressional Budget Office released a statement that said the U.S. economy could contract by 1.3% in the first half of 2013 if the Bush-era tax cuts expire and the automatic federal spending cuts become a reality. That certainly does not make people confident and put them in a mood to expand business through expenditures.

First, I believe the likelihood of the US Congress allowing the tax cuts to expire is slim. The CBO report gives the Congress perfect cover to do what they want to do anyway, which is to leave well enough alone. The rule in politics is to delay a decision until a decision is no longer needed. A delay seems likely and thus no immediate harm to the economy. What is interesting to note is that they are saying that hiking taxes hurts the economy. You don't hear that from politicians who are in favor of hiking taxes on all or part of the tax base. There is recognition here that the money is better left in the private sector where it will do the most good. The report was, in that regard, very refreshing.

There is also the recognition of the hurt caused by a sudden reduction of a hundred billion dollars in spending by the federal government. The potential impact is harder to measure because it does not happen often, but logic would tell us there is a need to dial back slowly on government spending or else a recession will ensue. Look at Greece, Italy, and the UK as examples. The argument for a gradual decade long reduction is thus enhanced. Please do not misunderstand me; I believe federal and state spending needs to be matched to revenue. The reality is that there is a short-term cost associated with that action.

Lastly, please note that the talk of a downturn in 2013 is new to the news media and to Washington, but ITR Economics has been warning clients about this for the last several years. The only difference is that we expect the economy to begin to slip slower in the latter half of the year with a potential for actual recession beginning late in the year.