US worst-case scenario: going over fiscal cliff

by Marc Jourdier, AFP

Posted at Nov 24 2012 03:09 AM | Updated as of Nov 24 2012 11:09 AM

WASHINGTON - Letting the US economy go over the fiscal cliff would push the United States, and probably other countries, into a new crisis that political leaders now say they are determined to avoid.

The fiscal cliff, a combination of mandated tax increases and spending cuts, will occur in January unless President Barack Obama and Democratic and Republican lawmakers forge a long-sought deal.

If they fail, federal government spending for the 2013 fiscal year, which began on October 1, will be slashed by $109 billion.

Tax increases would be broad-based. According to the Tax Policy Center, a nonpartisan research center, nearly 90 percent of Americans would pay more taxes, boosting the country's tax revenues more than 20 percent above what they would be without the cliff.

Middle-class households would be hit with an almost $2,000 tax increase on average.

Economists fear that the tax hikes, likely to curb consumer spending, combined with sharp cutbacks in federal spending, would drive the world's largest economy back into recession.

The US Federal Reserve has warned for months that it lacks the means to prevent the economy from falling back into a slump. Despite massive support from the central bank, the struggling economy has not yet fully recovered from the Great Recession that ended in June 2009.

Federal Reserve chairman Ben Bernanke, who coined the term "fiscal cliff," has put the onus on Washington to unlock political gridlock and come up with sustainable budget plans.

According to the latest projections from the Congressional Budget Office (CBO), the fiscal cliff would result in the economy shrinking 0.5 percent in 2013, and the unemployment rate would rise to 9.1 percent, compared with the 7.9 percent jobless rate in October.

An economics professor at the University of Maryland, Peter Morici, sees that scenario as too optimistic.

Morici said the fiscal cliff could trigger "cataclysmic consequences" for the economy.

"Unemployment would rocket past 15 percent, state government finances would collapse, homeowners would default on mortgages, and hundreds of banks would fail," he said.

IHS Global Insight analysts noted that the fiscal cliff is just one of several global events the firm had analyzed for the its worst-case outlook for 2013.

The doom scenario also incorporates a worsening of the eurozone financial crisis, escalating conflict in the Middle East and a hard landing in China's economic slowdown.

The scenario "is predicated on a confluence of these events happening in succession, significantly impacting global demand and commodity prices in 2013," IHS Global Insight analysts said.

US gross domestic product (GDP) would shrink 1.7 percent 2013, they projected, but that would be mild compared with recessions in other countries, such as Italy or Spain, where the contraction would exceed 4 percent.

The nonpartisan CBO predicts that if the economy topples over the cliff, the budget measures will reduce the government deficit to 4.0 percent of GDP in 2013, from 7.6 percent in 2012.

For former Republican congressman Bill Frenzel, now a guest scholar at the Brookings Institution, toppling over the fiscal cliff "is good policy, but only if you like recessions, enjoy unemployment, and don't mind living in the ashes."

"Responsible politicians will avoid it at all costs."

With the fiscal cliff imminent and the November 6 elections over, Obama and leaders of Congress have said they would do everything they can to find a compromise to avoid it.

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