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Recession averted, but rising debt still a threat, CBO warns

The CBO forecast on the economy describes the dilemma lawmakers face. Their successful measures to avoid a recession have left in place an expected dangerous rise in the national debt.

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Economists differ on how the sequester would affect the economy, if it goes into effect. For its part, the nonpartisan CBO estimated that the spending cuts would have a sizable cooling effect in 2013 – about 0.6 percent of GDP – but not to the point of causing a recession. The tax hikes contained in January's fiscal-cliff deal, the CBO estimated, will further slow GDP for the year by a similar amount.

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In that deal, Congress pushed taxes higher for high-income earners, while making Bush-era tax rates permanent for the vast majority of Americans. The cliff deal also allowed a temporary 2 percent payroll-tax break for US workers to expire.

The good news in the fiscal-cliff deal was that a recession may have been averted.

Back in November, the CBO warned that the expiration of the Bush tax rates, combined with other scheduled tax hikes and spending cuts, "will probably cause the economy to fall back into a recession next year." Many other economists agreed.
 
But if a near term threat was dodged, the new reality of low tax rates leaves the nation poised to dig itself deeper into debt. The new tax cuts, in fact, now account for most of the roughly $7 trillion in deficit spending that the CBO envisions for the decade from 2014 to 2023.
 
There's nothing wrong with low taxes, in general. The problem is the prospect of federal deficits that total 4 percent of GDP each year – and widening. That's a recipe for fast-rising public debt even without any recession or economic crisis.
 
Many budget experts say the solution to this problem, ultimately, must include reforms to control the costs of entitlements such as Medicare, Medicaid, and Social Security.

That's because those three programs account for nearly half of federal spending, and that share appears likely to expand. Such reforms are politically difficult, but could be phased in to avoid sharp consequences for the economy in the near term.
 
The CBO report warned of "serious negative consequences" if the debt problem goes unaddressed. The risk of failing to take action on the rising national debt is that it could slow economic growth, expose the US to a possible crisis of investor confidence, and siphon federal resources increasingly toward entitlements and away from investments that keep the nation economically competitive.

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