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Director of the Congressional Budget Office Douglas Elmendorf. GettyThe nonpartisan Congressional Budget Office is warning that if $607 billion in tax increases and spending cuts all hit as scheduled -- roughly the beginning of next year -- the U.S. will likely go into recession in 2013.

This is the "fiscal cliff" you may have heard about. But while economists, the Federal Reserve, and members of Congress have been warning about its approach for some time, the CBO's report is the first detailed analysis of its potential effects.

A Recipe for Recession

All of the following are scheduled to occur around the turn of the year, and together make up the so-called fiscal cliff:

  1. The expiration of the Bush-era tax cuts, including a 3% to 5% upward income-tax adjustment and a 5% increase in the capital-gains tax.
  2. A return of the alternative minimum tax, which could affect those with yearly incomes as low as $30,000.
  3. A 2% payroll tax increase, which had temporarily been cut for 2011 and 2012.
  4. $1.2 trillion in automatic budget cuts, because the president and Congress failed to pass a deficit-cutting package in the wake of last summer's debt-ceiling debate.

While we're on the subject, the debt ceiling is due to be raised again in early 2013, prompting fears of another credit-rating damaging battle between the White House and Congress.

Each of these events happening in turn would likely have some negative impact on our struggling economy. But it's all of them happening at basically the same time that has the CBO so concerned.

Doom and Gloom? Yes and No

According to the CBO, if nothing is done to stop or alleviate these "fiscal restraints," the economy is "expected to contract by an annual rate of 1.3% in the first half of next year." But the silver lining in taking these economic hits all at once is a reduction in the federal deficit of 5.1% in calendar years 2012 and 2013, and a reduction in the federal budget of $560 billion for fiscal years 2012 and 2013.

Conversely, if Congress and the president agree to extend all the tax cuts and not cut any spending, the U.S. economy could grow at a robust 4.4% next year. To do so, however, would come with continued growth of the national debt. The CBO calls this "unsustainable" over the long term, adding that "policy changes would be required at some point."



We Can Do This the Hard Way, or the Hard Way

The public debt is currently around 70% of GDP -- getting up into eurozone crisis levels, but without a hint yet of eurozone-level panic. For that, we can thank the fact that the U.S. dollar is still the world's reserve currency and Treasuries are still seen as the ultimate safe haven, which keeps yields low. This has shielded us from the ruthless vagaries of the sovereign bond market, which is currently giving the eurozone such a hard time.

Right now, Republicans want to renew the Bush-era tax cuts. Democrats want to let them expire, except for those with annual salaries of less than $250,000. Neither side wants the $1.2 trillion in automatic budget cuts to hit, but Republicans especially -- as a well-funded military is part of their political bread and butter.

Likewise, the Democratic party probably doesn't want a return of the alternative minimum tax, because the less-well-off, which the tax would hit hardest, have always been a greater part of its constituency. The payroll tax cut was championed by President Obama, but the rationale for it -- an economy in recession -- is gone.

And neither side ought to want another high-stakes, high-profile debt-ceiling debate. Last summer, it cost the country its coveted AAA credit rating. But depending on who's sitting in the oval office come 2013 and what parties come out ahead in the House and Senate, it may not even be an issue.


So the U.S. can take its licks now or later, but it will have to take them at some point along the way. The most sane and least painful way to do it would be to find middle ground between the two policy extremes outlined above -- one that would allow for a slower winding down of debt that keeps growth at a reasonable level, something the CBO also suggests.

The point is, there's clearly room in the coming fiscal-cliff showdown for maneuver, negotiation, and face-saving on both sides. Let's hope it's taken advantage of.


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PBanks

The Recession from 2008 to now in 2012. The recession was never over. Even up to now, the democrats are still making sure Unemployment checks are still at the full pool, of being paid out. The Democrats are talking out two sides of their mouths, making out the peopole who lost their homes and poor who was pushed out onto the streets have found a place to live and a job in the last 6 months. What world are you living in? They have changed the accounting formula for the unemployed and the jobs being got and the places they are working. If we actually look at it, we could find out if the Unions acrosss this country has cooked the numbers for the unemployed and the so called hires. The recession was never over, it still is very much alive and well and kicking. The Wall Street bubble the last several months will go bust before the year is out, they will have to make the adjustment.

July 18 2012 at 5:19 PM Report abuse rate up rate down Reply
donut999

Increased taxes are coming no matter how the election shakes out. Bush tax cut, expiring 3 years too late, has to happen. This is not a tax increase, it is simply the delinquent expiration of a tax cut. The legislation would have never been passed without the 10 year expiration. Agree with many of the other comments on here that is time we take ourselves to the woodshed painful as it is going to be. If the U.S. government was a person trying to buy a home, no one would even take the credit application.

May 29 2012 at 12:08 PM Report abuse +1 rate up rate down Reply
1 reply to donut999's comment
chris1011

And yet the entire world comes here to buy our treasuries at close to zero rates.

May 29 2012 at 12:35 PM Report abuse rate up rate down Reply
1 reply to chris1011's comment
chris1011

No, he did not take 500 billion out of Medicare. That is a bald faced lie.

May 29 2012 at 11:27 PM Report abuse rate up rate down
Holli, Chaney

Take the Entire hit in one hit. Rather than wait and draw out 20year of recession.

May 29 2012 at 7:05 AM Report abuse rate up rate down Reply
1 reply to Holli, Chaney's comment
donut999

Agree. Being the new Japan is not the answer.

May 29 2012 at 12:08 PM Report abuse rate up rate down Reply
Holli, Chaney

WELL THE 607 BILLION CUTS ARE OVER 10 YEARS WITH MOST OF THEM TAKING PLACE IN THE LATER YEARS OF THE 60 BILLION A YEAR TAX CUTS..FROM A NEARLY 4 TRILLION BUDGET.. THE BUSH TAX CUT IF IT EXPIRES 100% WILL BE ABOUT 100 BILLION UNLESS THEY JUST DO THE RICH..THEN IT WILL BE ABOUT 35 BILLION. ITS ALL PENNYS AGAINST OUR SPENDING..

May 29 2012 at 6:49 AM Report abuse rate up rate down Reply
1 reply to Holli, Chaney's comment
Holli, Chaney

With projected deficit increase of 100 billion this year. were going to about break even.

May 29 2012 at 7:00 AM Report abuse +1 rate up rate down Reply
vc462

It is an election year, & there is no way that Congress wont renew the tax cuts-the debate is whether taxes will inrease 3% or so on those making over $200K/yr ONLY.
Neither party wants to increase taxes on those making less than $200k/year. It's just that Republicans are political grandstanding the issue (like the pointless debt ceiling limit charade), trying to hold the whole tax cut renewal hostage unless they can protect the ultra rich from paying a tiny amount more.
Republicans may worsen the recession, if there's austerity & cuts only. . Weve already seen that tax cuts for the wealthiest isnt creating jobs. This economy is consumer driven & the middle calls doesnt have as much income to spend, which boosts the economy, providing more jobs.

May 29 2012 at 3:15 AM Report abuse rate up rate down Reply
mieldebebe

Let me get this straight. The auto cuts and expiring tax cuts that will throw us into a double dip recession will only reduce our deficit by 5.1% or a measely $66 billion???

Man this is just so sad, it cannot even get any more sad.

Oh wait .... yes it can ... and that is even sadder still!

May 29 2012 at 2:36 AM Report abuse +1 rate up rate down Reply
1 reply to mieldebebe's comment
Holli, Chaney

Europe is in meltdown because of their debt.. We had better move faster than this before we melt down as well.. We already started this past month.

May 29 2012 at 7:04 AM Report abuse +1 rate up rate down Reply
mieldebebe

A recession is better than the reset button of total collapse. I say we take the entire hit now. Then we can start to grow from a plateau of reason.

May 29 2012 at 12:57 AM Report abuse rate up rate down Reply
mieldebebe

A recession is better than the reset button of total collapse. I say we take the entire hit now. Then we can start to grow from a plateau of reason.

May 29 2012 at 12:57 AM Report abuse rate up rate down Reply
rwhitzler

Vote Obama 2012! ...yeah, right.

May 29 2012 at 12:36 AM Report abuse -1 rate up rate down Reply
SPQR

Everyone was a greedy pig over the last decade and it is now over!!!!!!

May 28 2012 at 11:55 PM Report abuse +3 rate up rate down Reply
3 replies to SPQR's comment