Substantial changes to tax and spending policies are scheduled to take effect in January 2013, significantly reducing the federal budget deficit. According to CBO’s projections, if all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5 percent in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013)—reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year. That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013. After next year, by the agency’s estimates, economic growth will pick up, and the labor market will strengthen, returning output to its potential level (reflecting a high rate of use of labor and capital) and shrinking the unemployment rate to 5.5 percent by 2018.

Output would be greater and unemployment lower in the next few years if some or all of the fiscal tightening scheduled under current law—sometimes called the fiscal cliff—was removed. However, CBO expects that even if all of the fiscal tightening was eliminated, the economy would remain below its potential and the unemployment rate would remain higher than usual for some time. Moreover, if the fiscal tightening was removed and the policies that are currently in effect were kept in place indefinitely, a continued surge in federal debt during the rest of this decade and beyond would raise the risk of a fiscal crisis (in which the government would lose the ability to borrow money at affordable interest rates) and would eventually reduce the nation’s output and income below what would occur if the fiscal tightening was allowed to take place as currently set by law.

In August, CBO presented estimates of the budgetary and economic outcomes that would occur under current law and under an “alternative fiscal scenario” that represents a continuation of many long-standing policies and thus a significant reduction in the amount of fiscal tightening next year. To provide additional information about the sources of that tightening and its effects, this report presents estimates of the budgetary and economic impact of the main changes to current law that would occur under that alternative scenario, as well as estimates of the impact of eliminating various other components of fiscal tightening scheduled for 2013.

In order to focus on the short-term impact of policy decisions, the analysis in this report is based on the assumption that the fiscal tightening would be removed and current policies maintained for two years and that the tightening provided by current law would occur thereafter. (In contrast, CBO’s August analysis of the alternative fiscal scenario was based on the assumption that those current policies would be maintained indefinitely.)

On the basis of its analysis, CBO concludes the following: