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U.S. Fiscal Cliff and Debt Primer
Bloomberg BRIEF: Economics
Joseph Brusuelas
December 2012
2. U.S. Fiscal Cliff and Debt Primer
Executive Summary
• Expiring tax and expenditure policies if not addressed with likely trigger
a US recession in early 2013.
• Policymakers have not moved significantly toward resolving
differences over fiscal policy, setting stage for fiscal shock in early
2013
• Due to liquidity constraint in economy end of tax holiday or tax cuts
likely to have greater impact than generally acknowledged
• Federal Reserve will likely resume treasury purchases in advance
of economy hitting cliff at December 2012 meeting.
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3. U.S. Fiscal Cliff and Debt Primer
Executive Summary
• Negative growth rates of -3.1 percent in 2013 in contrast to the
Bloomberg consensus forecast of a 2 percent rate of growth.
• Personal Consumption
• End of Bush tax cuts reduces household expenditures by $200
billion or roughly 1.3 percent of GDP.
• End of Obama tax holiday reduces personal spending by $95
billion, subtracting 0.6 percent from overall output.
• Assuming multiplier of 0.75%
• Larger multiplier results in greater hit on consumption and
growth
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4. U.S. Fiscal Cliff and Debt Primer
Estimated Effects of Fiscal Tightening
Potential Increase in 2013 U.S. Real GDP by Eliminating Mandated Spending Cuts and
Extending Tax Provisions
3.5%
2.9%
Percentage Point Change in Baseline GDP
3.0%
2.5%
2.0%
1.5% 1.4%
1.0%
0.7%
0.5% 0.4% 0.4%
0.0%
Defense Spending Cuts Non-Defense Spending Bush-Era Tax Breaks Payroll Tax Holiday Total Potential Increase
Cuts in GDP
Source: CBO Mid-Point Projections, November 2012, Bloomberg
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5. U.S. Fiscal Cliff and Debt Primer
Estimated Effects of Fiscal Tightening
Comparison of Potential Increase in 2013 U.S. Real GDP by Extending Tax Provisions
3.5%
3.0%
Percentage Point Change in Baseline GDP
Little Difference in GDP Growth by Not Extending Tax Breaks to Upper
Income Households
2.5%
2.0%
1.5% 1.4%
1.3%
1.0%
0.7%
0.5%
0.0%
Extend Payroll Tax Holiday Extend Tax Breaks for Incomes <$250,000 Extend Most Bush-Era Tax Breaks
Source: CBO Mid-Point Projections, November 2012, Bloomberg
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6. U.S. Fiscal Cliff and Debt Primer
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Executive Summary
• Unemployment likely to reach 9 percent by mid 2013
• Sequestration to hit public sector and defense related jobs hardest
• Private sector already pushing back hiring and reducing
investment.
• If economy hits cliff, private firms will be aggressive in shedding
jobs in Q1’13.
• Debt Ceiling
• December 15
• US Treasury announced it will take technical steps to extend point
at which the Federal Government exhausts funds until late
February or early March.
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7. U.S. Fiscal Cliff and Debt Primer
Repeat of 2011 Debt Ceiling Debate Looming
U.S. Debt Quickly Approaching Ceiling
$18 $0.0
$16
-$0.4
$14
-$0.8
$12
Room Remaining, tln (rs)
$10
U.S. Public Debt Subject to Limit, tln (ls) -$1.2
U.S. Statutory Debt Limit, tln (ls)
$8
-$1.6
$6
$4 -$2.0
1995 1998 2001 2004 2007 2010 2013
Source: Bloomberg
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8. U.S. Fiscal Cliff and Debt Primer
Fiscal Multiplier
• Understanding Multipliers
• A multiplier of zero means that an exogenous change in income will have no effect
on GDP growth.
• A multiplier of one indicates that a change in income will result in a one-for-one
change in GDP.
• A multiplier greater than one means that GDP will change by more than the
exogenous change in income.
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11. U.S. Fiscal Cliff and Debt Primer
Fiscal Multipliers
• The estimation of the impact of fiscal multipliers among economists remains an intensely
debated topic.
• Under current economic conditions estimation of multipliers suggest serious risk of
weaker pace of consumption, negative growth and rising unemployment.
• Consumer Behavior
• Save lump sum tax rebates
• Spend income related to Bush cuts and Obama tax holiday
• Lower income groups take much larger hit
• Liquidity constraints suggest likely larger multiplier effects
• Impaired credit system
• 13 million mortgages with negative equity or near negative equity
• Consumers rapidly drawing down savings
• Sluggish wage growth and falling earnings
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12. U.S. Fiscal Cliff and Debt Primer
Consumers Not Well Prepared for Decline in After Tax Income
U.S. Household Savings Has Declined along with Wages
14 10
9
12
8
Avg. Hourly Earnings (yoy %) (smo.)
10 7
Savings Rate (%) (smo.)
6
8
5
6
4
4 3
2
2
U.S. Savings Rate (%) Average Hourly Earnings (yoy %) 1
0 0
1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: US Bureau of Economic Analysis; Bloomberg
PIDSDPS, USHEYOY INDEX <GO>
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13. U.S. Fiscal Cliff and Debt Primer
Consumers Not Well Prepared for Decline in After Tax Income
U.S. Consumer Credit Growth Remains Below Average
Year-over-Year Percent Change in Total Consumer Credit Outstanding
25
20
15
Total HH Credit (yoy %)
10
5
0
-5
-10
1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
Source: Bloomberg CCOSYOY INDEX <GO>
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14. U.S. Fiscal Cliff and Debt Primer
Economic Efficiencies
Efficiency of Eliminating Mandated Spending Cuts and Extending Tax Provisions
(Relative to Budgetary Costs in 2013)
1.4
1.2
1.2
Dollar of GDP per Budgetary Costs
1.0
0.9
0.8
0.7
0.6
0.6
0.5
0.4
0.2
0.0
Defense Spending Cuts Non-Defense Spending Bush-Era Tax Breaks Payroll Tax Holiday Total Potential Increase
Cuts in GDP
Source: CBO Mid-Point Projections, November 2012, Bloomberg
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16. U.S. Fiscal Cliff and Debt Primer
Percentage Point Change in the Real GDP Growth Rate (from the Baseline
Estimates) Under Elimination of Bush-Era Tax Cuts
Lower Income Multiplier
Upper Income
Multiplier 0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75
0.00 0.0% -0.3% -0.6% -0.8% -1.1% -1.4% -1.7% -2.0%
0.25 -0.1% -0.3% -0.6% -0.9% -1.2% -1.5% -1.8% -2.0%
0.50 -0.1% -0.4% -0.7% -1.0% -1.3% -1.5% -1.8% -2.1%
0.75 -0.2% -0.5% -0.8% -1.0% -1.3% -1.6% -1.9% -2.2%
1.00 -0.3% -0.5% -0.8% -1.1% -1.4% -1.7% -2.0% -2.2%
1.25 -0.3% -0.6% -0.9% -1.2% -1.5% -1.7% -2.0% -2.3%
1.50 -0.4% -0.7% -1.0% -1.2% -1.5% -1.8% -2.1% -2.4%
1.75 -0.5% -0.7% -1.0% -1.3% -1.6% -1.9% -2.2% -2.4%
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17. U.S. Fiscal Cliff and Debt Primer
Economic Efficiencies
Comparison of Potential Increase in 2013 U.S. Real GDP by Extending Tax Provisions
1.4
Extending Tax Breaks to Upper Income Households Is Least
Efficient in Generating GDP Growth
1.2
Percentage Point Change in Baseline GDP
1.0
0.8
0.7
0.6
0.6
0.5
0.4
0.2
0.0
Extend Payroll Tax Holiday Extend Tax Breaks for Incomes <$250,000 Extend Most Bush-Era Tax Breaks
Source: CBO Mid-Point Projections, November 2012, Bloomberg
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18. U.S. Fiscal Cliff and Debt Primer
BGOV: Automatic Sequestration
• Office of Management and Budget will instruct federal government agencies to cut
$103.9 billion from budgets.
• $54.7 billion from non-defense discretionary and entitlement programs including
Medicare
• Total non-defense discretionary spending cut by 8.2 percent.
• $54.7 billion from the Pentagon and other defense related programs.
• Defense outlays reduced by 9.4 percent.
• Agencies likely to delay cuts until late February or early March in hopes that an
agreement can be reached.
• If sequestration occurs roughly half the cuts will occur in 2014 extending fiscal drag over
next two years.
• If sequestration is implemented under current law it will continue through 2021 in the
form of budget caps.
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21. U.S. Fiscal Cliff and Debt Primer
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Deficit and Debt Dynamics
• Longer Term Policy Tradeoffs Demand Near Term Action
• US Federal debt to GDP ratio stands at 101 percent.
• Period of fiscal restraint necessary
• Periods with greater investment as a share of GDP are highly
correlated with faster growth and rising living standards
• One risk, among many, to the U.S. economy is that rising
entitlement spending will require the government to borrow a
finite amount of capital from private savers, squeezing out
private firms who need that capital to expand the businesses and
increase productivity.
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22. U.S. Fiscal Cliff and Debt Primer
Deficit Dynamics
Fiscal Cliff and Long Run Implications for US Deficit
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
0
-200
-400
U.S. Deficit ($ Billions)
-600
-800
-1000 Increased debt service
Maintain Medicare Rates
-1200 Avoid Sequestration
Extend Other Tax Breaks
-1400
Extend Income Tax Breaks
Baseline Deficit
-1600
Source: Congressional Budget Office
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23. U.S. Fiscal Cliff and Debt Primer
Debt Dynamics
US Total Public Debt as Percentage of Nominal GDP
120
110
100
90
80
Percentage
70
60
50
40
30
20
10
1981 1986 1991 1996 2001 2006 2011
Source: Bloomberg
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24. U.S. Fiscal Cliff and Debt Primer
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Debt Dynamics
• Longer Term Policy Tradeoffs Demand Near Term Action
• U.S. federal spending on mandatory entitlements will likely
increase from $2 trillion in 2012, to $2.8 trillion in 2017.
• Spending on entitlements as a share of GDP increased from 4.9
percent in 1962 to an estimated 13.5 percent in 2012. In
contrast net fixed business investment will probably decline to
1.7 percent in 2012, down from 3 percent in 1962
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25. U.S. Fiscal Cliff and Debt Primer
Entitlement Spending vs. Net Fixed Business Investment
16
Net Business Fixed Investment
Mandatory Entitlement Spending Actual Forecast
14
12
Spending as a Percentage of GDP
10
8
6
4
2
0
1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 2022
Source: Bloomberg, CBO
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26. U.S. Fiscal Cliff and Debt Primer
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Debt Dynamics
• Longer Term Policy Tradeoffs Demand Near Term Action
• Over time the spread between net fixed business investment and
mandatory outlays has widened.
• Continuing on this path will result in reduced productivity levels,
slower growth, higher unemployment and an overall lower
standard of living.
• Between 1967 and 2011 the difference between spending as a
percentage of GDP in net business fixed investment has
increased from 0.7 to 12 percent.
• During the five years prior the spread was 0.92
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27. U.S. Fiscal Cliff and Debt Primer
The Fiscal Path and U.S. Debt
Debt Dynamics a Risk to Fiscal Sustainability
1.6
Nominal GDP Growth Annual Growth in Federal Debt
1.4
1.2
1
Annual Growth (Trillions)
0.8
0.6
0.4
0.2
0
-0.2
-0.4
1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010
Source: Bloomberg
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28. U.S. Fiscal Cliff and Debt Primer
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Debt Dynamics
• Stabilizing Debt to GDP Ratio at 101 Percent
• Nominal GDP of 3.9 percent.
• Long term borrowing costs of 1.5 percent.
• US can run primary budget deficit of 3 percent.
• Stabilizing debt to GDP at current elevated levels.
• Debt and Deficit Dynamics
• Running $1.3 trillion dollar deficits while economy adds roughly
$600 billion on nominal basis is not sustainable.
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29. Bloomberg
Joseph Brusuelas,
Senior Economist
Bloomberg, LP
jbrusuelas3@bloomberg.net
Joseph Brusuelas is an analyst who writes for the Bloomberg Economic Brief. The observations he makes
are his own. Bloomberg is a leading source of data, news, and analytics for financial and legal professionals,
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