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Dallas Fed Report: Fiscal Cliff's Greatest Impact Could Come From Spending Cuts

For immediate release: December 27, 2012

DALLAS—While many view the fiscal cliff as a single entity, it’s actually a series of six major fiscal events, with across-the-board cuts in federal spending potentially having the greatest short-term economic impact, according to the latest issue of the Federal Reserve Bank of Dallas’ Economic Letter.

Economic Letter can be found at: http://dallasfed.org/research/eclett/2012/el1214.cfm

In “Falling Off the Fiscal Cliff,” senior research economist and advisor Jason Saving breaks down the fiscal cliff provisions into separate parts, providing brief analysis of each: income tax increases, alternative minimum tax expansion, labor-market support reductions, higher health care taxes, Medicare reimbursement reductions and submitting to a sequester or across-the-board spending cuts.

Saving points out that the various components of the fiscal cliff don’t contribute equally to any negative economic impact.

“It would appear that letting the 2001/03 tax cuts [widely known as the Bush tax cuts] expire would have a large impact because this component is among the biggest fiscal cliff budget items ... However, the cuts are estimated to have the fourth-largest impact, behind the sequester, labor-market provisions and AMT patch,” he says.

The sequester looms large because of a fiscal “multiplier” effect from reduced government purchases and layoffs.

According to Saving, the nation is set to face deficits for the foreseeable future—but they’ll be a lot larger under some circumstances than others.

“If none of the expiring fiscal cliff provisions are extended past 2012, the CBO estimates that deficits would gradually fall to 1.2 percent of GDP and remain there for the next decade. If the fiscal cliff and smaller “fiscal clifflets” later in the decade were deferred in perpetuity, however, annual deficits would never fall below 4 percent of GDP and would reach 5.5 percent by 2022—leaving the U.S. poorly positioned to cope with the fiscal challenges of expected Social Security and Medicare shortfalls,” he writes.

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Media contact:
James Hoard
Federal Reserve Bank of Dallas
Phone: 214-922-5307
Email: James.Hoard@dal.frb.org

 

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