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Forecast: Taxmageddon Would Cause Another Recession

Posted By Salim Furth, Ph.D On July 7, 2012 @ 8:39 am In Featured | Comments Disabled

Speaking this week at the Western Economic Association International, economic forecaster Allen Sinai talked about the damage the “fiscal cliff” of 2013 will cause the economy. Sinai concludes that a recession is unavoidable if Congress does not act to fix the fiscal cliff.

The fiscal cliff has two components: (1) Taxmageddon, a $494 billion per year increase in tax increases set to take effect on January 1, 2013, and (2) federal spending cuts of about $135 billion.

In the large-scale economic model that Sinai’s Decision Economics Inc. uses to predict economic growth and fluctuations, the fiscal cliff has catastrophic consequences, but those consequences are not symmetric.

In Sinai’s model, a $350 billion tax increase—Sinai’s analysis shows that even a modest estimate of the 2013 tax increases has a huge, negative economic impact—would lower growth in 2013 by two percentage points and by more than two percentage points in 2014. The negative effects would persist until the long-run trend aspects of the model outweigh the effects of current policy. Given that growth in the U.S. has hovered around 2 percent throughout the recovery-less recovery, a $350 billion tax increase alone would reduce growth to zero for years.

In addition to the tax increases, Sinai modeled the effects of $135 billion in spending cuts. These resulted in about one percentage point lower GDP growth in 2013. Since GDP can be broken down into separate categories (government spending, consumption, investment, and net exports) and 1 percent of GDP is about $150 billion, the fall in government spending would have no measurable impact on the private economy in 2013.

In the years after 2013, the spending cuts actually yield a small increase in GDP in Sinai’s model—to the tune of two-tenths of a percentage point per year. That implies that decreasing government spending will increase future private economic activity on a better than one-to-one basis.

Lastly, Sinai emphasized that all those tax increases would have such a negative effect on spending that the deficit would shrink for only one year (2013) and would grow thereafter relative to a baseline with no fiscal cliff.

Other members of the panel had valuable insights as well. John B. Taylor of Stanford emphasized the importance of making economic policy based on consistent rules. As a frequent advisor to the U.S. government and a former Under Secretary of the Treasury, he recalled the pressure for government to “do something,” which made policy less predictable and sound. John C. Williams, president of the Federal Reserve Bank of San Francisco, expounded on Sinai’s and Taylor’s points. In discussions with business leaders from the nine states of Williams’ district, the topic of policy uncertainty came up again and again. Businesses do not want to hire or invest while tax rates and other future government policies are unknown.

Washington should stop Taxmageddon as soon as possible.


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