The United States’ economy could shrink as much as 4 percentage points in the first half of 2013 if Congress fails to address the expiration of $600 billion worth of tax breaks and jobless benefits by the end of this year, according to Goldman Sachs.
In a report issued on Tuesday, Goldman said in the worst-case scenario, the “fiscal cliff” facing the U.S. will shave almost 4 percentage points off gross domestic product (GDP) in the first half of 2013.
The fiscal cliff refers to the expiration of Bush-era tax cuts and the payroll tax holiday, as well as the end of extended unemployment benefits and the automatic spending and budget cuts mandated by Congress if lawmakers fails to reach deficit reduction goals.
According to Goldman, if the knock-on effects of a GDP contraction are considered, that is, reduced growth in one quarter weighs on the following quarter, the U.S. economy could experience a 5-percentage-point reduction in annualized quarter-on-quarter GDP.
The chances of the worst-case scenario actually happening are 35 percent, Goldman said, pointing out that a grand bargain was highly unlikely, thus raising the risks for the economy.
Republican Paul Ryan, who chairs the House Budget Committee, insisted it was Democrats who needed to cede ground on debt discussions. He said on CNBC's “The Kudlow Report" that the Democrats are to blame as they did "not put a budget that attempts to deal with any of these issues".
“While we see a small chance that a "grand bargain" is struck at year end (5% probability), there is a greater risk that Congress could fail to act and that the full amount of fiscal restraint could take effect at least temporarily,” Goldman said in the report.
Goldman believes there’s a 40 percent chance Congress will allow a short-term extension of the tax breaks and temporary increase in the debt limit by the end of the year. Such a move would allow lawmakers to postpone tough decisions until after the elections in 2013.
By CNBC’s Jean Chua.