The conservative Republican Study Committee (RSC) is calling for a three-pronged “cut, cap, and balance” deficit reduction plan that some experts believe would all but guarantee a double-dip recession. The second and third prongs—capping government spending at 18% of GDP and enacting a constitutional balanced budget amendment with supermajority thresholds for nearly every budgetary vote—are policies that would, when phased-in, severely exacerbate economic downturns. The Economic Policy Institute has repeatedly argued that Senate and House proposals to diminish government to around 18% of the economy—the lowest level since 1966 (one year after Medicare was enacted)—represent an extreme and unworkable assault on the Great Society and New Deal legislation. But the first prong—halving next year’s budget deficit—represents a new and alarming development in the budget debate, one that poses a catastrophic threat to the already anemic economic recovery.
Expansionary fiscal policy remains the best option for boosting jobs, and at this point perhaps the only one left. The economy is depressed, and the proposed extreme austerity measures will reduce economic activity even more (we’re still operating 5% below potential). Government spending is not “crowding out” private sector spending—it is actually “crowding in” private investment by creating additional consumer demand and supplementing diminished private sector spending as firms and households rebuild their balance sheets. Imposing austerity has very little scope to reduce long-term interest rates, which are at historically low levels thanks to the Federal Reserve and a depressed economy, but it can destroy consumer spending, which accounts for about 70% of the economy. It is striking how few serious economists dispute that immediate spending cuts will decrease economic activity. Those that try, such as the Heritage Foundation in their thoroughly discredited analysis of the House Republican 2012 budget, are forced to make “adjustments” to economic models to ensure their findings are consistent with their beliefs, and are rightly laughed out of the room.
The RSC plan proposes “immediate spending cuts to slash the deficit in half next year. According to March projections from the Congressional Budget Office, this would require spending cuts of approximately $380 billion in the 2012 fiscal year.” Their math is magnitudes off (the cuts would need to be more than 40% larger to halve the deficit), but this sum is nonetheless staggeringly high (ten-fold the spending reduction negotiated for 2011). Tax Policy Center blogger Howard Gleckman pointed out that there has never been such a large cut since the post-war demobilization and accurately characterized this plan as a prescription for a double-dip recession.
Moody’s Analytics chief economist Mark Zandi seems to agree that such a large cut would cause a double-dip recession. He recently estimated that every dollar of general government spending generates $1.40 in economic activity, implying that an immediate cut of $380 billion would reduce demand by roughly $532 billion, or 3.4% below projected levels. Instead of weak job gains that fail to keep up with population growth, we would return to seeing steep job losses, in both the public and private sectors.
In fact, actually halving the budget deficit would require considerably more severe austerity measures. Based on current law, the CBO projects a deficit of $1.08 trillion for the next budget year. If the administration’s request for war supplemental appropriations is met while current tax and Medicare physician payments policies are continued, we can expect a comparable $1.07 trillion deficit. In other words, halving the budget deficit would require roughly $540 billion of austerity measures in a single year. Relative to the CBO current law baseline, primary spending (excluding debt service) would be slashed 16%. Excluding base spending by the Department of Defense and emergency war spending would force considerably deeper across-the-board cuts. But these are static estimates; truly halving the deficit would require much more austerity because falling economic activity would counterproductively reduce revenue and increase automatic spending on economic stabilizers (such as food stamps and unemployment insurance, as more people will be forced to rely on them).
The administration, on the other hand, appears troubled by the labor market’s poor performance in May and downward revisions to growth forecasts. Growth has already slowed sharply. Decreased government spending at the federal, state, and local levels have dragged at the national income accounts for two straight quarters. The expiration of the Recovery Act is projected to result in about one percentage point evaporating from annualized growth—an outcome that was staved off for about a year by December’s tax deal but is again approaching. The administration is now discussing an employer-side payroll tax cut to further stimulate job creation. (December’s tax deal reduced payroll taxes by two percentage points on the employee side and continued emergency unemployment insurance, but no stimulus has been enacted since.)
More fiscal stimulus—even if long overdue and inadequate in magnitude—would be desperately welcomed news for 25 million un- and underemployed Americans. But slashing hundreds of billions of dollars from government programs or trying to halve next year’s budget deficit will only serve to put millions of more Americans out of work and, as others have predicted, all but guarantee a return to recession. Budgets are more than a bunch of numbers on a ledger, and economic policy is not a game to be played for short-run partisan gain. This is serious, and members of the Republican Study Committee should start taking it that way.