Unemployment Compensation
The Middle Class Tax Relief and Job Creation Act of 2012 extended emergency unemployment benefits through the end of 2012, although at a lower level than in 2011. If they expire on schedule, personal income would be cut by $35 billion in 2013.
The "Doc Fix"
In its perennial attempt to rein in surging Medicare costs, Congress in 1997 imposed a severe 32% cut in the reimbursement rates that physicians receive for treating Medicare patients. Those cuts are always scheduled to take place, but to date, they have not been implemented. Congress has repeatedly delayed the start date of the cut in reimbursement rates, an action dubbed the "doc fix." Indeed, reimbursement rates are typically raised, but not by much. The reasons are not hard to find: physicians have significant lobbying power, and in any event, they can choose to stop treating Medicare patients if reimbursement rates are pushed too low.
The most recent edition of the doc fix is scheduled to expire at the end of 2012. Unless it is renewed yet again, payments to physicians will drop by $15 billion in 2013.
Adding It Up
All of the spending hits and tax increases listed above, plus an additional $140 billion in miscellaneous spending and revenue adjustments that the CBO does not itemize, would together reduce the 2013 federal budget deficit by an astounding $808 billion. That amounts to 5.2% of our estimate of gross domestic product (GDP) for 2012. That would be one of the largest tax increases in US history outside of a major war.
Note that is a static estimate because it does not take into account the economic feedbacks that such a bout of fiscal austerity would produce. For example, to the extent that higher taxes on investment income reduce capital spending or that higher payroll taxes reduce consumer spending, national income would be lower than otherwise and, consequently, so would tax revenue.
The Economic Impact Of Driving Off The Fiscal Cliff
I do not believe we can accurately forecast what would happen to the U.S. or global economies if the federal government drives off the fiscal cliff. There are too many imponderables. Still, I think we can give a general description of the potential consequences. Both the demand side and the supply side of the economy would be slammed hard.
The Recession of 2013
Government spending would be cut sharply because of the sequester. The impact would be complex and uneven. For example, the sharp cuts in military spending would hit the defense industry hard, and major businesses in that sector have warned that they would have to layoff thousands of workers as contracts get cancelled.
Consumers would suffer a substantial decrease in their after-tax incomes, mostly because of higher taxes on incomes, wages and estates, but also because of cuts in unemployment compensation. Consumers would certainty slash spending in response to a large drop in their incomes.
Workers, facing higher tax rates, would have less incentive to work harder or longer in 2013, but those who have discretion over their hours might want to work more in the second half of 2012 when tax rates are lower. On the other hand, those unemployed facing a cut in unemployment compensation in 2013 might find it necessary to accept lower-paying jobs instead of continuing a search for higher-paying jobs.
Businesses would likely reduce capital investment. They would be burdened by less generous depreciation allowances and much higher tax rates on dividends and capital gains, all of which would raise the cost of capital. A higher cost of capital raises the rate of return companies require on investment projects; less profitable investments would be dropped. Moreover, the slump in spending by consumers and government would also give businesses reason to delay investment.