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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