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Even if government could attain the revenue levels of seven years ago, it wouldn’t come close to covering spending, which crossed the $3 trillion mark, in inflation-adjusted dollars, in 2009. Neither Republicans nor Democrats are suggesting reducing total year-over-year spending.
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.
Given low estimates for economic growth over the coming years, any attempt to reduce the debt-to-GDP ratio before Obama leaves office will thus require significant spending cuts in the near term.
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 1990s, Canada, 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.
In an October 2012 study published in the National Bureau of Economic Research, Alesina and Ardagna point to Canada (1993-1997), Sweden (1993-1998) and the U.K. (1994-2000). In these cases, spending cuts had a positive effect on private investment while improving consumer and business confidence by reducing the expectation of higher taxes.
Obama said in September that he would cut $2.50 in spending for every new dollar of tax revenue - what he has called a “balanced approach.” Yet his proposal for dealing with the fiscal cliff - $1.4 trillion in new tax revenue and $400 billion in spending cuts - represents a $3.50 increase in taxes for every $1 of cuts, assuming the reductions take place.
As the history of deficit-reduction frameworks (including those signed by Republican Presidents Ronald Reagan and George H.W. Bush) has shown, when immediate rate increases were “balanced” by spending cuts down the road, the spending cuts are never made.
In any case, recent experience shows that even if Obama’s 2.5-to-1 ratio of spending cuts to revenue increases came to pass by some miracle, it is far too timid. Economist David Henderson estimates that during the 1990s retrenchment in Canada, the government cut spending by $6 to $7 for every new dollar of revenue it raised.
Obama and Boehner have been largely silent on the specifics of their cuts, though both seem bent on slicing off parts of old-age entitlements such as Medicare and Social Security long after they are out of office.
The best holiday gift the president and Congress could give the country is to spend the final weeks of 2012 working on an honest plan to cut spending here and now.
Note: This article originally appeared at Bloomberg View on December 18, 2012. Read it there by clicking here.