The U.S. economy will sink into a deep recession and unemployment will jump back above 9 percent if Congress does not avoid a "fiscal cliff" waiting at the end of the year, according to a Congressional Budget Office study published Wednesday.
The report is the latest, possibly most dire, warning of the consequences of congressional inaction on more than $600 billion in spending cuts and tax increases currently mandated to take effect at the start of 2013. The question is whether it will spark more action, and just how helpful that action would be.
This news could also be used as a weapon by both sides in the political debate in Washington, with President Barack Obama's opponents using it as evidence of his poor stewardship of the economy, and those on the left suggesting that Republicans in Congress have deliberately endangered the economy by becoming die-hard deficit hawks once Obama took office.
If Congress can't get its act together long enough to avoid this fiscal tightening, then economic growth in the U.S. will shrink by 0.5 percent in 2013, and unemployment will rise to 9.1 percent from 8.3 percent today, the CBO, a nonpartisan budget watchdog, said in a new report on its website.
The CBO's forecast marks a sharp downgrade from May, when it said it expected the economy to grow 0.5 percent in 2013 despite the fiscal cliff.
The recession would be ugliest at the start of the year, according to the CBO: It said that it expects inflation-adjusted gross domestic product to shrink at a 3.9 percent annualized rate in the first quarter of 2013 and shrink another 1.9 percent in the second quarter if the fiscal cliff is not avoided. Those would be the worst marks for GDP since the end of the recession in 2009.
If Congress manages to avoid the fiscal cliff altogether, then the CBO sees the economy growing by 1.7 percent next year and unemployment drifting lower to 8 percent -- hardly an economic boom by any stretch.
The CBO said the federal budget deficit would shrink in either scenario -- to $641 billion if we reach the fiscal cliff, and to $1.04 trillion if the cliff is avoided. It pegs the budget deficit for 2012 at $1.12 trillion. Federal debt as a percentage of GDP will shrink to 58 percent from 73 percent if the economy goes over the fiscal cliff, and will swell to 90 percent of GDP if the fiscal cliff is avoided, according to the CBO.
But if the fiscal cliff is avoided, the CBO says that the higher debt burden that comes as a result would lead to longer-term bad news for the economy, eventually pushing interest rates higher and slowing down economic growth.
"Ultimately, the policies assumed in the alternative fiscal scenario would lead to a level of federal debt that would be unsustainable from both a budgetary and an economic perspective," the CBO writes.
Politicians on both sides of the aisle generally seem to agree with this view -- although high budget deficits have not yet resulted in the spike in interest rates that budget hawks have long feared. In fact, U.S. Treasury interest rates were recently at a record low. It is almost as if, as former Vice President Dick Cheney once said, budget deficits don't matter. Cheney rescinded that view once Obama took office, part of a renewed Republican focus on deficits that contributed to the 2011 debt-ceiling crisis, the resolution of which set the stage for the fiscal cliff.
But observers on the right and the left have warned that panic about the dangers of the fiscal cliff could lead to poor budget decisions if Congress acts too hastily. Chad Stone at the left-leaning Center on Budget and Policy Priorities warned in June:
The greater danger is that misguided fears about the economy going over a "fiscal cliff" into another Great Recession will lead policymakers to believe they have to take some action, no matter how ill-conceived and damaging to long-term deficit reduction, before the end of the year, rather than craft a balanced plan that supports the economic recovery in the short term and promotes fiscal stabilization in the intermediate and longer run.
In his report, Stone cited a May 2012 study by the not-so-left-leaning Carlyle Group entitled "There Are Worse Fates Than Walking Off The Fiscal Cliff" that said, "While the fiscal cliff would be a near-term disaster, an extension of 2012 fiscal policy that fails to address increasing indebtedness could actually represent the worst long-run outcome."
For better or worse, recent history suggests that hasty action by Congress might well be the least of the country's worries.