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The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts

CRS – The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts. Jane G. Gravelle, Senior Specialist in Economic Policy, September 20, 2012

  • “A major policy concern for Congress is when and whether to address the “fiscal cliff,” a set of tax increases and spending cuts that would substantially reduce the deficit in 2013. In projections made in March 2012 by the Congressional Budget Office (CBO), this fiscal restraint, constituting 5.1% of output in 2013, would reduce growth to 0.5% from 4.4%. Unemployment would increase by 2 million. In August, updated estimates projected growth at a negative 0.5%. Policy choices with respect to the fiscal cliff are difficult because of the conflict between short-run and long-run economic and budgetary objectives. In the short run, the reduction in demand from the reduced budget deficits could damage an already fragile recovery. In the longer run, however, deficit reduction is needed to address a projected unsustainable debt level. For FY2013, compared with FY2012, the policy-related fiscal cliff is $502 billion, 80% reflecting tax increases. There is an additional $105 billion from economic changes. The expiration of the 2001, 2003, and 2009 tax cuts (extended in 2010) and the expiration of the alternative minimum tax (AMT) “patch,” which indexes the AMT exemption for inflation, account for 44% of the policy-related fiscal cliff. Other tax provisions include expiration of the temporary two percentage-point reduction in the employee’s Social Security payroll tax (19%); the expiration of other tax cuts, including depreciation and the “extenders” (13%); and taxes scheduled to come into effect as a part of health reform (4%). Spending reductions include the automatic spending cuts under the Budget Control Act (13%); the expiration of extended unemployment insurance benefits (5%); and the “doc fix” that will lower Medicare payments (2%). Most changes take effect after 2012, although the AMT and many of the extenders expired after 2011.”
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