Fiscal Policy, Even “Avoiding the Cliff,” Looks Negative for 2013
As I always point out, Goldman Sachs has an excellent research department, led by Jan Hatzius. Their economic forecasts are almost always on target; if there’s one thing Goldman understands, it’s money. They were the ones who found that federal fiscal policy turned negative in mid-2010. And they now have updated that forecast, incorporating the possibilities for the fiscal slope.
The chart above shows three different scenarios. The first incorporates the expected expiration of the payroll tax cut and the implementation of the Affordable Care Act. Some Medicare taxes on the wealthy begin January 1, and it’s highly likely those will occur on schedule. So if that takes place, federal fiscal policy will take away close to 1.75% from GDP growth in the first two quarters of 2013, before moderating back to around -1% by the end of the year. And that’s under the best-case scenario, where the payroll tax cut expires and the Medicare taxes begin and nothing more.
The expiration of the high-end Bush tax cuts doesn’t do very much more to retard growth. That small mid-tone gray sliver you see reflects the end of both those tax cuts over $250,000 and extended unemployment compensation. My guess is that the unemployment extension accounts for most of that reduction, which nudges total GDP reductions above 2% only for the first quarter of 2013.
The dire scenario, reflecting the expiration of all fiscal slope programs, is dire. In the first quarter of 2013, GDP drops by 4%, and gets to around 4.5% in the second quarter before coming back slightly. Even by the fourth quarter, GDP falls 1.75% as a result of letting everything expire.
The thing about the fiscal slope is that it’s a slope. Congress won’t have just one shot at an agreement, but a series of shots. People won’t pay thousands of dollars in new taxes and spending won’t reduce by billions right on January 1. So Congress will have time to ameliorate the situation even if they completely fail by the end of the year. That’s where this chart comes in handy, to increase pressure for a deal.
And what this shows is that the tax cuts on the first $250,000 of income, and most especially the sequester spending cuts, would do the most damage to the economy. A situation where the high-end tax cuts expire and pay to offset the sequester would still create a drag on growth, but a manageable one, and one where just about everything is avoided that’s on the table right now (obviously unemployment benefits should be extended as well). The ideal scenario would be to not only keep fiscal policy constant for another year, but to pass the American Jobs Act and add some deficit spending. But everyone’s desperate to end that payroll tax cut, and Goldman Sachs clearly shows the result of that. A dovish position is the proper position on the deficit right now, when the recovery remains fragile.
What this chart further shows is that federal fiscal policy currently drags on growth by around 3/4 of 1%. That has created growth in 2012 of under 2%. So clearly, the adverse scenario here portends a recession. But even the best-case scenario would forecast out to dampened growth, probably under 2%, for 2013. This is what they mean by Japanification; an endless low- or no-growth situation.