It’s not often we at MarketMinder make non-capital markets-related forecasts, but this is a special occasion: We forecast the CBO’s most recent forecast for the US’s economic outlook will prove rather off-base. First, though, a brief update on the latest from the CBO.
Wednesday, the CBO announced downward revisions to its 2012-2013 US forecast, predicting the US will face a “significant recession” during the first half of 2013 if Congress does nothing to address the impending “fiscal cliff.” The CBO now expects the US economy in 2013 to grow only 1.7%, down from an original forecast for 4.4% growth—assuming Congress will “do something” to address the fiscal cliff before January 2013. Without Congressional intervention, though, the CBO forecasts US GDP will decline by 0.5% in 2013, also down from January’s estimate for 1.1% growth.
So what prompted the revisions? The CBO cites two primary reasons for the change: the “steepening” of the cliff due to Congress’s extending payroll tax cuts and unemployment benefits, both of which now also expire in January 2013, as well as slower-than-anticipated economic activity.
The media broadly reacted quite negatively to the news, publishing headlines like, “CBO Warns of Significant Recession if Congress Doesn’t Act to Avoid Fiscal Cliff,” and “‘Fiscal Cliff’ Would Spark US Recession.” (The sharp reaction seems a bit odd considering the CBO said largely the same in a report issued in May.) And indeed, those are rather steep revisions to the earlier forecast. But before you start weatherizing for the impending economic storm—and a US recession is always possible— let’s take a step back and consider some … well, anomalies.
First, the CBO is hardly a bastion of ironclad, reliable forecasting. After all, how often do you read news reports revisiting its prior forecasts and assessing the degree of accuracy? We can’t identify one instance—and our own assessment tells us their track record is quite spotty. Not that the CBO is entirely to blame—attempting to forecast the output of an economy the size and scope of the US’s is beyond daunting. What’s more, the CBO is most often called upon to score costs for certain initiatives based on assumptions they’re handed—by politicians. It’s not in the CBO’s purview to comment on whether said assumptions are likely to play out as politicians suggest. Which means in their latest economic forecast, they likely aren’t considering potentially mitigating factors—like, say, the probability politicians do what’s politically expedient, though it may be at the 11th hour.
Now, let’s draw out a few implications of the CBO’s revisions. The primary stated driver of the revisions was the fact payroll tax cuts and extended unemployment benefits are now also set to expire at the end of 2012. And the downward revision to the full-year 2013 GDP forecast is 2.7 percentage points. Think about that—if extended unemployment benefits expire and payroll taxes revert to marginally higher rates, GDP’s expected to be fully 2.7 percentage points lower than if the fiscal cliff is averted. That’s a huge dent in a roughly $15.1 trillion economy—in fact, it implies those two things alone would shave some $405 billion off economic activity.
But in 2010, total extended unemployment benefits paid (Fed and state) were only $9.12 billion. And in 2010 (prior to the 2% payroll tax cut), total federal payroll tax revenues amounted to $637 billion. All else equal, that means the payroll tax cut would’ve left about $205.5 billion more in consumers’ hands. (Something we’re in favor of.) For a grand total of … about $215 billion. Not close to $405 billion—by a long shot.
Maybe the CBO disagrees! Maybe it assumes the payroll tax base has nearly doubled. Yet there’s little evidence of such a monumental upshift in economic growth since 2010, and if there were, we strongly doubt many would be too terribly worried about the so-called fiscal cliff. To get to that $405 billion, you’d need a multiplier of nearly two times. Fair enough—could happen! But historically, equating a dollar less taxed to a dollar more spent has proven a fallacy.
Granted, maybe the CBO’s factoring in a few other things—like a slowing economy or something similar. Still, it seems to give quite a bit of credit to what are in actuality relatively minor economic factors in the scheme of things. What’s more, it points to the perils of trying to make so specific an economic forecast—there are myriad factors acting on the economy.
And one of those very material overlooked factors? The enormous elephant (or donkey, for that matter) in the room: politicians! And politics. Both of which have a significant role yet to play—if politicians can be relied on for anything, it’s being politically expedient. And as we’ve argued before, there seems to be little incentive for politicians on either side of the aisle to do nothing about the fiscal cliff. Sure, they likely drag their feet and hem and haw as long as possible, but it seems relatively unlikely they won’t take some action—even if it’s delaying ultimate action—before all the cuts and tax hikes and, and, and kick in.
So the morals of the story are many, but primarily: A US recession is always a possibility. But CBO forecasts should always and everywhere be read with a healthy dose of skepticism (and possibly an abacus at hand, for purposes of double-checking).