Could true spending cuts stimulate the economy?

posted at 12:11 pm on December 18, 2012 by Ed Morrissey

When conservatives insist that spending cuts — actual spending cuts, and not reductions in the rate of federal expansion — the common rebuttal is that reductions in federal outlays would touch off a massive recession.  But would that actually be true?  Nick Gillespie and Veronique de Rugy look at the experience of Canada in the 1990s and the US after World War II and conclude the opposite for Bloomberg.  The path to significant economic stimulus, they argue, is the decline of the “debt overhang” that has accelerated in the last twelve years:

Both the president and members of Congress worry that rapid spending cuts would cause a new recession or slow down the recovery. Such fears are overstated.

In the 1990sCanada, for instance, reduced debt-to-GDP ratios through an aggressive combination of actual, year-over- year spending cuts and higher taxes. The result wasn’t malaise but a burst in activity.

The same happened in the U.S. right after World War II. In 1944 and 1945, annual government spending (in 2005 dollars) averaged about $1 trillion and represented more than 40 percent of GDP. By 1947, it had plummeted to $345 billion in 2005 dollars and 14 percent of GDP. Even facing the demobilization of millions of soldiers, the economy soared and unemployment fell despite almost universal fears that the opposite would happen.

Such outcomes are not flukes. Research by economists Alberto F. Alesina and Silvia Ardagna underscored that fiscal adjustments achieved through spending cuts rather than tax increases are less likely to cause recessions, and, if they do, the slowdowns are mild and short-lived.

What’s more, when spending reductions are accompanied by policies such as the liberalization of trade and labor markets, they are more likely to have a positive impact on growth.

While many economists — and certainly all politicians — worry that turning off the spigot of public spending will shrink an economy (and anger constituents receiving the cash), the opposite is likely to be true.

The true problem for the economy is the historical highs of federal spending as a percentage of GDP:

The OMB estimates that annual government spending from 2013 to 2016 will average $3.25 trillion in 2005 dollars, or 22.7 percent of GDP. Whether measured in constant dollars or as a percentage of the economy, the government has never once reached that level of revenue, much less sustained it for a number of years.

We have been arguing this for the last several years.  So far, though, the message doesn’t seem to be sinking in with the voters (as today’s WaPo/ABC poll shows) or the political class.  The latter case might be easier to explain.  Today’s Washington Post notes the boom-town results for the Beltway with the federal spigots turned up to firehose levels:

With plenty of two-income highly educated families, the D.C. region already has a reputation as one of the most affluent in the country. But the area is fast emerging as a home to the truly rich as well.

High-end luxury retailers are responding. Brands such as Aston Martin are expanding their operations into the area — betting, for instance, that there will be plenty of customers who can afford the $280,000 sports car James Bond drives in the movies. Nearby in Tysons, a Saint Laurent store and the high-end electric car maker Tesla are also set to open their doors.

The region’s top one percent of households make more than a half million dollars yearly — far more than the national average for the one percent, according to a study of Census data by Sentier Research, an Annapolis-based data analysis firm.

And these top earners — many of whom are from dual-income households and benefit from federal contracting — weathered the recession better than their counterparts in some other metropolitan areas and the nation. More are moving beyond comfortable affluence to a much higher standard of living.

“What is unique to D.C. is that there has been a change in the complexion of wealth here. There didn’t used to be much of this ultra-high-net-worth business here and now there is,” said Susan Traver, the regional president of BNY Mellon Wealth Management.

Gee, I wonder how that happened?  We don’t have a revenue problem.  We have a spending problem, but more specifically, we have a spoils problem.  When the federal budget gets used to enrich the political class and their cronies, we won’t get many of them to admit that the problem isn’t that they don’t have enough wealth to redistribute.


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Couldn’t hurt.

Bmore on December 18, 2012 at 12:16 PM

That’s an understatement for those of you who don’t get me.

Bmore on December 18, 2012 at 12:17 PM

Or it.

Bmore on December 18, 2012 at 12:17 PM

Start making videos of their houses, their cars, and their upscale retail locations. As movie goes, mark both Democrats and Republicans to show that there is no difference between the parties when it comes to pocket lining. Flood YouTube with these videos. Turn the class warfare meme upside down! Yes, we have to begrudge people their money when that money is made off our taxes!

Archivarix on December 18, 2012 at 12:19 PM

We’ll never know.

Tharn on December 18, 2012 at 12:20 PM

Lower taxes on everyone, lower taxes on businesses, lower regulations on businesses, getting rid of bhocare would be great ways to stimulate the ecomony!

And while you are at it, cut spending! But little or none of this will be done, so we just keep cratering the US!
L

letget on December 18, 2012 at 12:20 PM

Government workers hardest hit…

PatriotRider on December 18, 2012 at 12:29 PM

Spending cuts? Might help a little.

The problem is that everyone with investment cash realizes that we have a flaming communist in the White House and have zero confidence in this clown.

Philo Beddoe on December 18, 2012 at 12:31 PM

Unfortunately it’s not in this President’s DNA

Tater Salad on December 18, 2012 at 12:33 PM

Big Government…… is too big to fail

FlaMurph on December 18, 2012 at 12:33 PM

There’s a bit of quackery in that post WWII scenario. They fail to mention THE PENT UP CONSUMER DEMAND THAT ACCUMULATED OVER 4 YEARS. People had well-paying jobs during the war years AND NOTHING TO SPEND IT ON.

GarandFan on December 18, 2012 at 12:35 PM

I LOVE THE NEW/old PELOSI-SCHUMER plan that Boehner is proposing.

But it doesn’t go far enough…….the Federal government should just seize all private property and end all this partisanship.

Conservatives should lead the way by volunteering up all forms of self-defense, all assets and all form of opposition to the Communist Democrats.

THAT will certainly end all the bickering right?

PappyD61 on December 18, 2012 at 12:41 PM

TAKE IT ALL Mr. President!!!!!

Do it!

PappyD61 on December 18, 2012 at 12:42 PM

Both the president and members of Congress worry that rapid spending cuts would cause a new recession or slow down the recovery.

The government doesn’t want to cut spending because that’s how they pay off their cronies and special interests and secure their power over the rest of us. They may claim they fear spending cuts will cause an economic recession but what they really fear is a government recession.

FloatingRock on December 18, 2012 at 12:44 PM

Here’s a crazy idea. What we should do is decentralize the federal government. Take away from it those functions where there is disagreement between regions on how they should be carried out, and on other matters such as the size and scope of government. Let the regions make their own decisions on what the government looks like.

Each region could have its own system of elected representation, which would be more accountable to the region’s citizens, as each citizen would have more relative influence.

This of course, would make it unnecessary for the central government to tax individuals (the root of the entire problem we have today), as they would raise money from the regions, who would raise money in a manner consistent with the desires of their citizens.

We could call the regions “provinces”, or, maybe “states” would be more appropriate…

mr.blacksheep on December 18, 2012 at 12:47 PM

The gop leadership IS NOT CONSERVATIVE!!!!

They are not standing for Conservatism.

Actions say they are Big government loving Progressives.

PappyD61 on December 18, 2012 at 12:47 PM

Could true spending cuts stimulate the economy?

Such spending cuts should AT LEAST be tried. Prove their effectiveness or not.

Noting that the Left is SUUURE without attempt or trial that they can’t be done or, uhh, can’t be done.

Reduce spending. Like how you as an individual have to do when you have ten dollars but you owe twenty, you have to start somewhere, like, say, spending only nine and not twenty-five on credit.

Lourdes on December 18, 2012 at 12:49 PM

The government is the furthest thing from an efficient user of money. Pretty much any money that the government doesn’t take and spend is used better by private business and individuals. We can see this glaring and obvious truth just from the pathetic record of the Barky years; over 8% of GDP borrowed and spent by the feral government every single year in order to crow about less than 2% of GDP in “growth”. It would be funny if it weren’t so pathetic and stupid. And yet, we see so many people who are pushing to maintain that super-deficit spending, with a NEGATIVE return, in order to not have to acknowledge the contraction of the real economy that has been taking place all this time. If we would ever take the hit and then the actual economy might have a chance to recover – and it would – though at this point we’ve piled on so much debt that we are in danger of interest rates getting back to where they belong and crushing us with the debt service (though this problem never goes away without a straightforward resolution, which no one at the feral level, in the government or the Fed, is even giving any serious consideration to).

But, one thing is clear, another couple of years of this insane deficit spending and we will be beyond the point of monetary no return. We need to cut spending as quickly as possible and we might still have a chance to emerge from this Indonesian-caused (and Boner abetted) disaster of fiscal insanity and monetary lunacy.

No matter the situation, it is a truism that government will never spend money correctly or efficiently, which is why federal government spending is supposed to be restricted to the basics – national defense and the few actual domestic responsibilities enumerated in the Constitution.

ThePrimordialOrderedPair on December 18, 2012 at 12:53 PM

The Senate and the Executive Branch exist to spend. At least, that’s how they’re characterized recently: “pork” for those who they favor is what they think they’re in government to siphon off. It’s a personality problem of who and what a Senator is as also a President, at least today and especially to the Democrats.

Worse, that’s now creeped into the House: too many Congresspeople now assume they’re elected to “get more” from the taxpayers and not to provide a service, especially when that service, as today much needed, is conscientious fiduciary responsibility.

We as a nation DO have a spending problem. We have to address it, remedy it. Unfortunately, the more desperate the population becomes (without jobs, sick, crime, etc.), then the more desperate the taking is by Congress and any President who, like Obama, won’t grow up and stop using others.

Lourdes on December 18, 2012 at 12:54 PM

SCoaMF rejected the abortion (Plan B).

game playing

they all lose

so-notbuyingit on December 18, 2012 at 1:03 PM

What’s a spending cut?

-Washington DC

tommer74 on December 18, 2012 at 1:07 PM

Many great comments here, unfortunately the corporate media has a vested interests, (billions of dollars worth), in preserving the beltway status quo.

And a note for those who misunderstand, when I say “corporate media” (MSM), it’s not because corporations are necessarily bad, I support free market capitalism, but the corporate MSM has is just another group of beltway cronies with a vested interest in preserving the corruption that pays so well and serves their statist objectives.

FloatingRock on December 18, 2012 at 1:15 PM

In order for the free market to thrive, government needs to go into a recession, and let’s hope it’s a depression in government spending because that will be the best thing for America.

FloatingRock on December 18, 2012 at 1:22 PM

Calvin Coolidge gave us the Roaring 20s.

FDR gave us The Great Depression.

End of lesson.

LoganSix on December 18, 2012 at 1:33 PM

While many economists — and certainly all politicians — worry that turning off the spigot of public spending will shrink an economy (and anger constituents receiving the cash), the opposite is likely to be true.

Let’s be honest. They don’t care about what it will do for the economy. They worry about what it will do to the scope of their power.

CycloneCDB on December 18, 2012 at 2:01 PM

While I’m all for spending cuts, this argument has already been rebutted by a paper from Roemer at all; the economic expansion via spending cuts in those periods was due largely to a decline in interest rates as the bond market rewarded the lower debt, which freed up capital. However, due to the Fed’s QE, interest rates are already about as low as they can get, so reducing our debt will not lower them.

Although lowering our debt will prevent them from rising much in the future; a rise in rates plus our huge debt ultimately will strangle our economy if nothing is done about it.

blue13326 on December 18, 2012 at 2:03 PM

Although lowering our debt will prevent them from rising much in the future; a rise in rates plus our huge debt ultimately will strangle our economy if nothing is done about it.

blue13326 on December 18, 2012 at 2:03 PM

Raising that debt through more inefficient (and mostly un-Constitutional) government spending certainly isn’t going to help. In fact, it will only hurt the situation – hurt it massively. And the Fed keeping rates artificially low gives an illusion (to those who yearn to be kept in the dark) of the ability to handle the current debt, let alone the massive increases people are claiming that our nation HAS TO HAVE!!! LOL. How dumb are people? It’s beyond ridiculous and one of the dimmest arguments in all of human history.

Tell me again how the feral government can borrow and spend over 8% of GDP and then actually claim “growth” of less than 2% GDP? What’s the multiplier on that puppy??? ROFLMAO … if it weren’t so fatal and ugly.

ThePrimordialOrderedPair on December 18, 2012 at 2:19 PM

In the 80s, when Ronald Reagan used a combination of spending increases and tax cuts, long prescribed by Keynesian fiscal policy, Dems cited that an increase in the deficit would “crowd out” private expansion.

It’s funny that no Dems can find a crowd-out factor now. I think only deficit spending by conservatives crowds out the private sector.

Axeman on December 18, 2012 at 3:18 PM

Could true spending cuts stimulate the economy?

Not really, but it would make things more tolerable.

Dr. ZhivBlago on December 18, 2012 at 4:18 PM

Many great comments here, unfortunately the corporate media has a vested interests, (billions of dollars worth), in preserving the beltway status quo.

And a note for those who misunderstand, when I say “corporate media” (MSM), it’s not because corporations are necessarily bad, I support free market capitalism, but the corporate MSM has is just another group of beltway cronies with a vested interest in preserving the corruption that pays so well and serves their statist objectives.

FloatingRock on December 18, 2012 at 1:15 PM

…darn right!…he’s (FR) long gone!…so don’t anyone tell him I’m agreeing with him…(when he’s not being anal!)
I’ll deny it!

KOOLAID2 on December 18, 2012 at 9:37 PM

Try actual tax cuts first, IMHO.

MelonCollie on December 19, 2012 at 8:48 AM