User:RoyGoldsmith//United States fiscal cliff

Timeline

• March 23, 2010: Obama signed into law the Patient Protection and Affordable Care Act. One of this law's provisions is to impose new taxes on families making $250,000 per year or more.
• December 17, 2010: Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, patching the AMT through 2011 and extending the Bush tax cuts to the end of 2012.
• August 2, 2011: Obama signed the Budget Control Act of 2011. This act provided that, if the Joint Select Committee did not produce bipartisan legislation, across-the-board spending cuts would take effect on January 2, 2013.
• February 22, 2012: Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012, which extended the following provisions until December 31, 2012: the 2% Social Security payroll tax cut, federal unemployment benefits and the freeze on Medicare physician payments.
• February 29, 2012: Ben Bernanke coined the term "fiscal cliff" in his testimony before the House Financial Services Committee.
• July 3, 2012: IMF head Lagarde warned that the threat of "going over the fiscal cliff" could weaken the US economy later in 2012. The IMF also reduced its projection for US growth in 2013 from 2.4 to 2.25 percent of GDP.
• July 17, 2012: Bernanke pushed Congress to avoid the fiscal cliff, warning that a failure to do so will further dampen the sluggish economic recovery.
• July 31, 2012: Reid and Boehner agreed on a continuing resolution that would pay for the day-to-day running of the government until the end of March 2013. This does not affect the fiscal cliff or the debt-ceiling.

Congressional Budget Office projections

US federal debt from 1940 to 2022. The right side of the diagram projects what would happen to the debt if Congress (a) allows current laws to take effect and reduce the deficit (the baseline) or (b) extends the current policies, such as keeping tax cuts in place (the alternative).

CBO Scenarios

Decisions regarding the fiscal cliff will have meaningful implications for deficits, debt, and economic growth. The Congressional Budget Office (CBO) has projected two fiscal scenarios for the years 2013 to 2022:

• The baseline projection. This scenario would have lower deficits and debt but also have lower spending and higher taxes.
• The alternative fiscal scenario. Higher deficits and debt but lower taxes and higher spending.

These paint starkly different fiscal futures. If Congress and the President do not act, allowing tax cuts to expire and mandated spending cuts to be implemented, the next decade will more closely resemble the baseline projection. If they act to extend current policies, keeping lower tax rates in place and postponing or preventing the spending cuts, the next decade will more closely resemble the alternate fiscal scenario.

Baseline projection. The CBO has been publishing baseline projections since 1985. Under "the baseline", tax cuts are allowed to expire and spending cuts are implemented in 2013, resulting in higher tax revenues plus lower spending, deficits, debt and interest for the next decade and beyond. Future deficits would be reduced from an estimated 8.5% of GDP in 2011 to 1.2% by 2021. Revenues would rise towards 24% GDP, versus the historical average 18% GDP. The total deficit reduction or debt avoidance over ten years could be as high as $7.1 trillion, versus the $10-11 trillion debt increases if current policies are extended. In other words, roughly 70% of debt increases projected over the next 10 years could be avoided by allowing laws on the books during 2012 to be implemented.

CBO estimates under the baseline projection that public debt rises from 69% GDP in 2011 to 84% by 2035. In the long run, lower deficits and debt should lead to relatively higher growth estimates. But, in the short run, real GDP growth in 2013 would likely be reduced to 0.5% from 1.1%. This would mean a high probability of recession (a 1.3% GDP contraction) during the first half of the year followed by 2.3% growth in the second half.

Alternate fiscal scenario. If Congress "avoids" the fiscal cliff, the future more closely resembles the continuation of 2012 policies, described by the CBO's "alternative fiscal scenario." This scenario involves extending the Bush income tax cuts, restricting the reach of the AMT, and keeping Medicare reimbursement rates at the current level (the so-called "doc fix", versus declining by one-third as mandated under current law). Revenues are assumed to remain around the historical average 18% GDP. Under this scenario, public debt rises from 69% GDP in 2011 to 100% by 2021 and approaches 190% by 2035. This scenario has considerably higher debt and interest payments than the baseline projection, but short-term impact on the economy is avoided.

Projected effects

CBO Infographic.

The Congressional Budget Office estimates that allowing certain laws on the books during 2012 to expire or take effect in 2013 (the baseline scenario) would cut the 2013 deficit approximately in half and significantly reduce the trajectory of future deficits and debt increases for the next decade and beyond. However, the 2013 deficit reduction would adversely impact the economy in the short-run. On the other hand, if Congress acts to extend current policies (the alternative scenario) deficits and debt will rise rapidly over the next decade and beyond, slowing the economy over the long-run and dramatically increasing interest costs.

CBO estimates that if the baseline scenario is allowed to take effect in 2013, it would reduce federal spending by $103 billion and increase tax revenues by $399 billion (and another $105 billion "mostly in revenue") up through September of 2013 (the end of FY2013). This would amount to a net total of $560 billion, roughly half the $1.2 trillion FY2011 deficit. The White House estimates that a family of four with an income of $50,000 to $85,000 would pay an additional $2,200 in federal taxes.

Thus according to the CBO, the following metrics will be in effect starting January 2013:

Fiscal or Economic Measure	CBO Baseline	Alternative Scenario
Federal deficit in FY2013	$641 billion	$1037 billion
Economic growth in FY2013	-0.5% of GDP	1.7% of GDP
Unemployment rate 4th quarter, 2013	9.1%	8.0%
Public debt in 2022	58% of GDP	90% of GDP

Consideration of these scenarios and other options will lead to a broad spectrum of fiscal policy choices.

Estimated deficit for the first year

CBO projections of the sources of deficit reduction in the FY2013 budget, not counting economic feedback.

  Expiration of tax cuts and the subsequent growth in the AMT: $221B (36.41%)

  Expiration of 2% FICA payroll tax cut: $95B (15.65%)

  Other expiring tax provisions: $65B (10.71%)

  Affordable Care Act taxes: $18B (3.97%)

  Spending cuts ("sequestration") under the Budget Control Act of 2011: $65B (10.71%)

  Expiration of federal emergency unemployment insurance: $26B (4.28%)

  Reduction in Medicare payment rates for doctors: $11B (1.81%)

  Other changes (mostly revenue, primarily reflecting economic growth): $105B (17.30%)

The CBO estimated that the total deficit of fiscal year 2012 (which ends on September 30, 2012) will be $1.171 trillion. The CBO also estimated that the total reductions to the fiscal year 2013 deficit by letting current laws take effect (which increase taxes and reduce spending) would be about $560 billion. Therefore, since the total US public debt was approximately $11.053 trillion as of July 2012, the public debt would climb by the end of FY2013 to either $11.664 trillion (if Congress does nothing, allowing current law to take effect) or $12.224 trillion (if the fiscal cliff is avoided, extending current tax and spending policies into the future), all other considerations remaining the same. This difference amounts to 5.07% of the federal debt in nine months.

Under current laws scheduled to take effect by the end of 2012, the total 2013 deficit will be $612 billion, as opposed to $1,171 billion for the previous year. The chart at the right contains a breakdown of the currently authorized reductions to the FY2013 deficit. The total of this chart is $607 billion but this is without considering economic feedback. Reduced taxes and increased spending, due to the 1.3% contraction in the first half of 2013, as well as other constraints, are expected to decrease the savings by $47 billion, giving a net total of $560 billion in deficit reduction during FY2013.

Effects of sequestration

Further information: Budget Control Act of 2011

The spending reduction elements of the fiscal cliff are primarily contained within the Budget Control Act of 2011, which directed that both defense and non-defense discretionary spending be reduced by "sequestration" if Congress was unable to agree on other spending cuts of similar size. Congress was unable to reach agreement and therefore the sequestrations are expected to take effect in early 2013. The scope of the law excludes such major mandatory programs as Social Security and most of Medicare.

The effect on both defense and non-defense discretionary spending will be significant if the cliff is not avoided. Cuts totaling $110 billion per year will be applied from 2013 to 2022, split evenly ($55 billion each) to defense and non-defense discretionary spending. For scale, discretionary funding for 2011 totaled $1,277 billion: budget authority of $712 billion for defense and funding totaling $566 billion for non-defense activities.

During 2013, defense and non-defense discretionary spending would be maintained around 2012 levels due to the sequester. However, the spending begins to rise thereafter, but not at the pace projected prior to the sequester. In other words, the trajectory of spending increases is reduced, but spending is not frozen at 2012 levels. Defense and non-defense discretionary spending increases from 2013-2021 would be about 1.5% annually, significantly below the prior decade.

For example, according to the CBO Historical Tables, defense spending (including overseas contingency operations for the wars in Iraq and Afghanistan) grew from $295 billion in 2000 to $700 billion in 2011, an annual growth rate of 8.2%. Non-defense discretionary spending grew at a 6.6% annual rate during that time, from $511 billion to $597 billion.

The austerity represented by the sequester is not unprecedented; from 1990-1999, defense spending actually declined by about 1% annually, from $300 billion to $276 billion, although non-defense discretionary spending grew by 4.5% annually, rising from $200 to $297 billion.

CBO estimated the possible impact on defense spending in October 2011 testimony: "Compliance with the caps on discretionary funding could occur through many different combinations of defense and non-defense funding. For example, defense and nondefense appropriations might be cut proportionally relative to the funding that would be necessary to keep pace with inflation. In that case, funding for defense programs apart from overseas contingency operations would drop from $552 billion in 2011 to $538 billion in 2012 before rising again and reaching $637 billion in 2021 (see Table 3). Between 2012 and 2021, such funding would be $445 billion less than the amount that would occur if the amount of funding for 2011 grew at the rate of inflation. When measured as a share of GDP, funding for defense would decline by about 1 percentage point from 2011 to 2021, or by more than one-fourth (see Table 5). Funding for defense in 2021 (excluding overseas contingency operations) would represent 2.7 percent of GDP; by comparison, annual funding for defense (excluding overseas contingency operations) has averaged 3.4 percent of GDP during the past decade."

CBO estimated the possible impact on non-defense discretionary spending in October 2011 testimony: "If defense and nondefense appropriations were cut proportionally relative to the funding that would be necessary to keep pace with inflation, nondefense budget authority would decrease from $511 billion in 2011 to $505 billion in 2012 before rising again and reaching $597 billion in 2021 (see Table 4). Between 2012 and 2021, budget authority for nondefense purposes would be $418 billion less than the amount that would be provided if funding grew at the rate of inflation after 2011. Under an assumption that the obligation limitations for certain transportation programs grow over time at the rate of inflation, nondefense funding in 2021 would represent 2.8 percent of GDP; by comparison, such funding has averaged 4.1 percent of GDP during the past decade (see Figure 6)."