Congressional Budget Office says massive spending cuts and tax hikes due in 2013 could lead to fiscal crisis.

The Congressional Budget Office (CBO) has said that the US economy can fall into recession, if the Congress fails to take action to stave off tax increases and automatic budget cuts scheduled for January 1.

The nonpartisan analysis, released on Wednesday, said massive spending cuts and tax hikes due next year would cause even worse economic damage than previously thought if Washington failed to come up with a solution.

Failure to avoid the so-called “fiscal cliff” of expiring tax cuts and automatic spending reductions would cause US gross domestic product to shrink 0.5 per cent in 2013.

Previously, CBO forecast full-year GDP growth of 0.5 per cent.

The first half of 2013 will be particularly difficult, the CBO said in its mid-year forecast update. Tax hikes and spending cuts will cause GDP to shrink 2.9 per cent in the first half, compared with a prediction in May for a 1.9 per cent contraction.

There will still be a slight bounce back in the second half of 2013, but it will be weaker, with growth of only 1.9 per cent, compared with a previous forecast of 2.3 per cent growth.



Gloomy projections

The main reason for the gloomier outlook is that the fiscal cliff is steeper than CBO previously estimated because of extensions earlier this year of a payroll tax cut and federal unemployment benefits, the CBO said.

It also said the general global and US economic outlooks have dimmed since its last report, another factor weighing on its projections.

For the current fiscal year, which ends September 30, the agency shaved its US budget deficit forecast to $1.128 trillion from $1.171 trillion, mostly due to lower-than-expected spending for the Medicare and Medicaid healthcare programmes.

In fiscal 2013, assuming that scheduled tax hikes and spending cuts take effect, the CBO said the deficit would shrink dramatically to $641bn.

This is slightly higher than its previous forecast of $612bn because of lower revenue and higher spending assumptions.