Dragged to the Fiscal Slope

Implications of “I am not a member of an organized political party. I am a Republican.” (with apologies to Will Rogers)

The collapse of Speaker Boehner’s Plan B has been interpreted as signaling that the Speaker never had the votes from his caucus for any deal with the President. [1] If this interpretation is correct, then we should prepare for something like the following trajectory of GDP:

Figure 1: Log GDP (blue), log forecast GDP under current law, from August 2012 (red), and GDP if all Bush tax cuts extended plus AMT fix (green square). NBER defined recession dates shaded dark gray; implied informal recession dates shaded light gray. Source: BEA, 2012Q3 3rd release; 2012Q4 assumes 1% growth SAAR (from MacroAdvisers (12/20/2012); CBO, Budget and Economic Outlook: An Update (August 2012), CBO, Economic Effects of Policies Contributing to Fiscal Tightening in 2013 (November 2012), NBER, and author’s calculations.I included a 2013Q4 projection of GDP assuming tax increases for income less than $250K are eventually eliminated (green square). In light of this evening’s events, I think this seems a bit optimistic –- it is not clear that the right wing of the Republican Party would allow a partial tax cut; all or nothing seems to be the current stance. In any case, this estimate is based upon the August 2012 CBO projection. To the extent that one believes the current-law trajectory of GDP is lower, the implied level of 2013Q4 GDP is commensurately lower.

As CBPP’s Chad Stone has pointed out, the CBO projection assumes immediate implementation of the provisions. Some could be delayed until some agreement could be made, thereby possibly avoiding a downturn (e.g., the green square in my optimistic scenario). One can only hope.


This piece is cross-posted from Econbrowser with permission.