Looking Over the Cliff

That fiscal cliff -- you know... the one everyone's all wound up about? Well, the Congressional Budget Office (CBO) just released their analysis of its potential impact on the economy and it ain't pretty. Add up all the stuff that's scheduled to turn into fiscal pumpkins at midnight on December 31, and you get about 5% of GDP (all the Bush tax cuts, automatic spending cuts, alternative minimum tax fix, payroll tax cut, unemployment insurance (UI) extension, and more!).

What impact might that have on the economy? Their best guess is that it means declining real GDP in the first half of next year to the tune of 1.3% (annualized; or around $100 billion through the first half), followed by growth of 2.3% in the second half of 2013, or 0.5% for the full year. Unemployment would reverse course and start rising if that fiscal scenario remained in place -- a big, important "if," as I'll return to in a second.

Suppose Congress enters full can-kick mode and extends everything -- a very bad idea, in my humble opinion. Then, according to CBO, the economy grows 4.4% next year and unemployment reliably continues its recent downward trend. CBO also estimates a middle-ground extension scenario where the payroll tax break and UI extension expire but most everything else stays with us. Under that regime, they project growth of about where we are now, around 2%.

By now, if you're still with me, you're probably torn -- at least I hope you are -- between the full-extension scenario to tap the higher growth rate and keep the recovery on track, and the fiscal and inequality-worsening agony of extending the high-end Bush tax cuts, the ones the President very clearly wants to finally sunset.

Well, here's the thing: CBO doesn't score that scenario -- what would happen to growth if the high-end tax cuts expired -- but a) it's a relatively small share of the full fiscal constraint package -- something in the neighborhood of $80 billion in 2013 out of about $600 billion; and b) equally important, because these high-income folks are not income constrained, the growth multiplier on their tax cuts is low, about 0.3 (give them a $1 tax cut and their extra spending will raise GDP by between 10 and 50 cents; that's the lowest of all the stimulus policies CBO evaluated). If these numbers are roughly right, $24 billion in 2013 foregone stimulus is a very small price to pay for permanent sunset of this part of the Bush tax cuts -- and I say that as a guy who really doesn't like forgoing stimulus, what with all this slack still in the system.

Finally, that big "if" I mentioned above. All of these estimates assume we go off the cliff and don't climb back. If, as Gail Collins imagines it, there's a bungee jump instead of a cliff dive, we can avoid the worst of this.

One hopes that Congress can hammer the kind of compromise that has eluded them thus far -- the one that adds tax revenues to any agreement -- before the end of the year. But if that doesn't happen, a retroactive agreement by the new Congress very early next year could work too.

This post originally appeared at Jared Bernstein's On The Economy blog.