If Congress does nothing, various tax and spending provisions will take $500 billion out of the economy in 2013. These provisions, collectively known as the “fiscal cliff,” include the expirations of the Bush Tax Cuts and the payroll tax cut, the spending cuts triggered by the failure of the Supercommittee, as well as other year-end changes.

The Congressional Budget Office recently released a report outlining what would happen to the U.S. economy if the fiscal cliff were allowed to occur. They found that the fiscal cliff would cause the economy to contract by an annualized rate of 1.3% in the first six months of 2013. Over the entire year, a post-fiscal cliff economy would grow by only 0.5%. By contrast, if current policies were allowed to continue, the U.S. economy would be projected to grow 4.4% in 2013.

At the same time, however, the CBO noted that indefinitely continuing current policies would create unsustainably high levels of debt. Under the CBO’s alternative fiscal scenario (see pages 3-4)—which assumes that the fiscal cliff is partially averted—debt held by the public would jump to 93% of GDP by 2022. By contrast, under current law (which assumes that the fiscal cliff occurs), debt held by the public would equal 61% of GDP in 2022, down from roughly 70% today. According to the CBO, the extra debt of the alternative fiscal scenario would reduce GNP by 2.5% in 2022, relative to current law.

What, then, should be done? The CBO describes one option:

An intermediate possibility is to extend some but not all current policies indefinitely (perhaps with some offsetting changes in other policies) or to extend or enact certain policies for a limited period. In particular, if policymakers wanted to minimize the short-run costs of narrowing the deficit very quickly while also minimizing the longer-run costs of allowing large deficits to persist, they could enact a combination of policies: changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period.

In other words, Congress should not allow the fiscal cliff to occur, but they should at the same time enact an alternative package of fiscal restraint that will reduce the deficit more gradually, over a longer-term timescale. However, the CBO makes clear that future fiscal restraint must be well-supported, or it could be easily be overturned by a future Congress. Stay tuned: Next week (update: here), I’ll show you why Social Security reform should play a prominent role in such future fiscal restraint.