CBO warns of U.S. falling off 'fiscal cliff'

Washington • A new government study released Tuesday says that allowing Bush-era tax cuts to expire and a scheduled round of automatic spending cuts to take effect would probably throw the economy into a recession.

The Congressional Budget Office report says that the economy would shrink by 1.3 percent in the first half of next year if the government is allowed to fall off this so-called "fiscal cliff" on Jan. 1 — and that the higher tax rates and more than $100 billion in automatic cuts to the Pentagon and domestic agencies are kept in place.

There's common agreement that lawmakers will act either late this year or early next year to head off the dramatic shift in the government's financial situation. But if they were left in place, CBO says it would wring hundreds of billions of dollars from the budget deficit that would "represent an additional drag on the weak economic expansion."

CBO projected that the economy would contract by 1.3 percent in the first half of 2013, which would meet the traditional definition of a recession, which is when the economy shrinks for two consecutive quarters.

"Such a contraction in output in the first half of 2013 would probably be judged to be a recession," CBO said.

At issue is the full expiration of two rounds of major tax cuts enacted during the Bush administration and automatic spending cuts on the Pentagon and domestic programs that are scheduled to take effect as punishment for the failure of last year's deficit "supercommittee" to produce a deficit-cutting agreement last year.

Last summer's debt and budget agreement imposed almost $1 trillion in cuts to agency budgets over the coming decade and required automatic cuts — dubbed a sequester in Washington-speak — of another $1 trillion or so over the coming decade.

The CBO study came as Capitol Hill is hopelessly gridlocked over spending and taxes in advance of the fall elections. The White House and top Democrats like Senate Majority Leader Harry Reid of Nevada say they will refuse to act on the expiring tax cuts and automatic spending cuts unless Republicans show greater flexibility on raising taxes.

"We're open to a balanced alternative plan for deficit reduction," Reid told reporters. "But if we can't do that, a deal's a deal."

Republicans are pressing to deal with the problem now. But they're not showing any more flexibility on tax increases.

"You can call this a fiscal cliff. You can call it Taxmageddon as others have done," said Sen. Orrin Hatch, R-Utah. "Whatever you call it, it will be a disaster for the middle class. And it will be a disaster for the small businesses that will be the engine of our economic recovery."

The results of the elections will have a lot to do with the ultimate solution, but several top lawmakers predict the current Congress will punt the issue into 2013 for the newly-elected Congress and whoever occupies the White House to deal with.

CBO is the respected nonpartisan agency of Congress that produces economic analysis and estimates of the cost of legislation.