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Spend Less, Grow Less, Slow the Economy

Spend Less, Grow Less, Slow the Economy

The Joint Economic Committee Republican (JEC-R) study “Spend Less, Owe Less, Grow the Economy,” which we critiqued last week, has attracted the attention of Paul Krugman and Ezra Klein.  They are incredulous — as were we — at the Republican JEC claim that sharply reducing government spending and laying off government workers are critical for creating jobs in today’s economy.

This is a dangerous policy prescription, and the International Monetary Fund (IMF) has effectively debunked the claim that international evidence shows it would work.  The IMF’s reading of the international evidence is that immediate sharp deficit reduction harms short-term economic growth, whether it is achieved primarily through spending cuts or tax increases.

While the IMF finds that growth falls less in episodes dominated by spending cuts, that’s mainly because the monetary policy response (how much interest rates are cut) has tended to be greater in such episodes than in those dominated by tax increases. That’s all a far cry from saying that the best thing for the U.S. economy is to cut spending immediately or that future U.S. deficit-reduction efforts should consist mostly or entirely of spending cuts.

Since the United States doesn’t have sharply rising interest rates or other symptoms of an imminent debt crisis, we shouldn’t be debating which immediate deficit-reduction steps would be least destructive to the economic recovery. Instead, we should be debating how to strengthen the recovery in the short run while putting in place a sound long-run deficit-reduction program. The international evidence cited in the JEC-R report offers no help in that regard.

The report offers Canada in the 1990s as a case study of a country that turned around a deteriorating budget situation by cutting government expenditures while enjoying stronger economic growth than it had prior to enacting those cuts.  But the JEC-R account leaves out a few important details, including the fact that, historically, Canadian economic performance has been closely tied to U.S. economic performance.

The chart below reproduces data for Canada from the JEC-R report on government expenditures at all levels as a share of gross domestic product (GDP) and economic growth and adds comparable U.S. data. Two things stand out:

  • The pattern of economic growth is similar in both countries, with growth falling in the slumps of the early 1990s and 2000s and rising in the subsequent expansions. The Canadian economy expanded at an average annual growth rate of 3.4 percent from 1993 to 2006, nearly identical to the 3.3 percent U.S. growth rate.
  • Yet the two countries’ budget policies were quite different.  Government expenditures were much larger as a share of GDP in Canada than in the United States in the early 1990s and remained larger even after Canada’s budget cutting.  And unlike Canada, the United States achieved impressive budget balancing without especially sharp reductions in government spending, in part by raising taxes on high-income taxpayers.

What I take from this is if you start with a level of expenditures significantly higher than the United States and then reduce expenditures at a time when your major trading partner is experiencing a strong economic boom (after raising taxes), you, too, can have a boom.

Where’s the lesson in that for the United States in 2011?  I can’t find one.

This post was originally published on the Off the Charts blog of the Center on Budget and Policy Priorities.

Read more: , , , , ,

Photo courtesy of Skibum415 via flickr
written by Chad Stone, Chief Economist at the Center on Budget and Policy Priorities

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85 comments

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8:44AM PDT on Apr 3, 2011

But you left SS & Med out of the calculation for the top "0.049%"
Which changes their tax burden to 22.4% from 8% of income.
While the $86k guy is at 8.1% of income & 16.6 tax burden.
Both are calculated including SS & Med.

8:24AM PDT on Apr 3, 2011

40 stores across the country is TOO many!?!?!

7:05AM PDT on Apr 3, 2011

There were two errors in my most recent comment.

I said the top 0.1% have an average income of $29 million and pay 20.8% of that income in federal tax. This should have been the top 0.01%. Average income and tax paid are correct.

I said someone making $86k would pay 21% of his income in federal income tax, social security tax and Medicare tax. For an employed individual, this should have been 17%, for self employed 24%.

The errors do not change my fundamental point.

10:12PM PDT on Apr 2, 2011

A fabric store chain is growing in popularity because people want to sew their own clothes to save money. So the chain is planning on opening 40 more stores this year! Like we need that many more stores? And when the economy improves, and people stop buying fabric, the stores will go out of business. Dumb cycle...

4:42PM PDT on Apr 2, 2011

Thanks!

10:50AM PDT on Apr 2, 2011

"David C if I could have given you two green stars I would. It's people like Duncan ONeil that really have no clue and are ruining this country."

No clue? I beg to differ!

9:58AM PDT on Apr 2, 2011

David C if I could have given you two green stars I would. It's people like Duncan ONeil that really have no clue and are ruining this country.

9:35AM PDT on Apr 2, 2011

The only way I would vote for a Republican or Democrat is if they would pay me the amount of money that is equal to the National Debt!!! I have voted for Green candidates whenever I can, and occasionally for a libertarian. Why doesn't somebody sue the Big 2 on anti trust laws?

6:23PM PDT on Apr 1, 2011

Duncan Oneil "Progressives already think they have control! Look at the mess they made since 2006!"
Oh please. The financial disater was in place by 2006 - fishy mortgages, trillions in credit default swaps. Dems/Reps each had 49 senate seats in 2007. The president was Rep. Do you seriously think past mistakes can be undone in two years with such minimal control.

"Show me how the "rich" are not paying taxes?"
In 2008, the top 0.1% of earners ($29 million per year) paid an average of 21% of income in federal tax. Including SocSec and Medicare, a guy making $86,000 also paid 21%. The rich can pay more with minimal effect on their quality of life. They could do something for their country.

"Remember for Government to pay its people require REMOVING money from the economy!"
Don't be silly. Government employees buy food, clothes, appliances, cars. Of course the money is not removed from the economy.

"a for profit business has to make happy customers" Yes?? Like mortgage brokers who made loans without checking ability to pay. They got their commission then left others holding the bag.

"There will be more money in the business community for investment, that is business growth. "
Today, most businesses have excess capacity. They can make more widgets than people want to buy. They need customers not investment. We escape recessions when people begin to buy again. This is how stimulus can help. Investments are needed for future growth.

5:37PM PDT on Apr 1, 2011

Unlike state run monopolies a for profit business has to make happy customers. Unhappy customers go elsewhere for their needs thereby putting the non-effective for profit out of business.

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