Economics

The Truth About Spending Cuts

Separating economic myth from economic fact

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Editor's Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth 1: Spending cuts will derail the economy.

Fact 1: The academic literature shows that successful cases of fiscal adjustment relied overwhelmingly on spending cuts, not tax increases.

While the political debate heats up over the short-term effects of spending cuts, there is a wide academic consensus that spending cuts are a major factor for achieving lasting debt reduction. In particular, empirical studies have shown that fiscal consolidations based upon spending cuts have been more effective than tax-based consolidations.

This chart consolidates data from five peer-reviewed studies examining the ratio of spending cuts to revenue measures in successful fiscal consolidations. It illustrates that the average successful fiscal consolidation was comprised of 80 percent spending cuts and 20 percent revenue measures.

An independent analysis performed by the American Enterprise Institute economists Andrew Biggs, Kevin Hassett, and Matthew Jensen confirms the literature's finding that fiscal consolidations that reduce ratios of debt to GDP tend to be based upon reduced government outlays rather than increased tax revenues. This result holds whether fiscal consolidations are defined in terms of improvements in the cyclically-adjusted primary budget deficit or in terms of pre-meditated policy changes designed to improve the budget balance.

Biggs, Hassett, and Jensen reviewed the extensive existing literature on fiscal consolidations. They also conducted their own data analysis to study that question. They used a large data set covering over 20 Organization for Economic Co-Operation and Development countries and spanning nearly four decades to isolate over 100 instances where countries took steps to address their budget gaps. Some of these fiscal consolidations were spending-based while others relied more on taxes. Here is what they found:

Our findings are striking: countries that addressed their budget shortfalls through reduced spending were far more likely to reduce their debt than countries whose budget-balancing strategies depended upon higher taxes.

The typical unsuccessful fiscal consolidation consisted of 53 percent tax increases and 47 percent spending cuts. By contrast, the typical successful fiscal consolidation consisted of 85 percent spending cuts. These results are consistent with a large body of peer-reviewed research.

These findings are also consistent with the research of Harvard's Alberto Alesina and Silvia Ardagna (here is another paper by Alesina on the issue).

The debate, of course, is far from settled. Yet as Biggs explained in his March 30, 2011 testimony before the House Ways and Means Committee:

[The debate] is not about whether spending-based fiscal consolidations are more likely to succeed than tax-based consolidations. Even using the IMF study's methods, spending-based consolidations are more likely to reduce deficits and debt than tax-based consolidations.

Second, the IMF study does not dispute that spending-based fiscal consolidations generate superior short-term economic outcomes than tax-based consolidations.

In other words, the least we can say about fiscal consolidations comprised primarily of spending cuts is that they shrink both deficits and the debt. In that context it is worth pointing to the work of former Obama administration Council of Economic Advisers Chair Christina Romer and her economist husband David Romer, which shows that increasing taxes by 1 percent of GDP for deficit-reduction purposes leads to a 3 percent reduction in GDP.

Myth 2: We can't balance the budget without raising taxes.

Fact 2: We can balance the budget simply by holding spending constant.

Fiscal balance can be achieved by holding spending constant, and by driving it toward its historical equilibrium.

In Reason magazine's March issue, Nick Gillespie and I proposed a 10-year balanced budget plan that would systematically reduce the projected growth in outlays (spending that hasn't occurred yet and hasn't even been appropriated) so that it equals the 19 percent of GDP that the Congressional Budget Office projects the federal government will raise as revenue if the current tax system is left unchanged. Effectively, under this plan, spending is frozen at its current levels and allowed to grow only for inflation. See the chart below.

In other words, we can balance the budget over the next decade without raising taxes if we ratchet down spending from its current level of 25 percent of GDP to 19 percent—a figure that would still leave spending well above the 18.2 percent of GDP that President Bill Clinton spent in his last year in office, a time when no one was complaining about a skin-flint federal government.

Another solution would be for Congress and the president to agree to reduce 1 percent from the federal budget each year until balance is reached. As my Mercatus Center colleague Jason Fichtner explains in this paper, the 1 percent reduction would be a real cut in spending, not just a reduction in the rate of growth of government. Once a balanced budget is reached, then spending could again be allowed to grow, but at rates consistent with the growth in the overall economy so that relative fiscal balance is maintained. A 1 percent reduction in spending does not necessarily mean a 1 percent cut across the board. Under this plan, Congress could still set priorities.

As Gillespie and I explained earlier this week in our piece assessing Rep. Paul Ryan's (R-Wisc.) Path To Prosperity plan,

if cuts such as these are not possible, it would be better to give up any pretense that we will ever restore the barest semblance of sanity to the federal budget and get on with fiddling as Rome burns. If we're going to continue hosting a party whose bill is unpayable, we might as well enjoy ourselves.

Myth 3: Paul Ryan's plan will dramatically cut spending.

Fact 3: Ryan's plan reduces spending between FY2011 and FY2012. After that it reduces the growth of spending. But overall spending grows by $1.1 trillion over 10 years under Ryan's plan.

At first glance, House Budget Chairman Paul Ryan's FY2012 Budget Resolution is a step in the right direction. With a determined moniker, "The Path to Prosperity," the Republican roadmap is oriented on spending cuts, debt reduction, and credible revenue expectations.

The plan is not too surprising to those of us who have followed Ryan's previous budget crusades. It concentrates on cutting government spending–reforming two of our three largest autopilot programs, Medicare and Medicaid–while recognizing that attempts at raising tax revenue will not support economic growth or fix our spending problem.

The new plan realistically projects that tax revenue as a percentage of the economy will grow as a result of economic growth and not from tax rate hikes. Under Ryan's plan tax revenue will consume 17.1 percent of the wealth created by American families, a number that is more in line with the government's abilities to collect money. This is a serious improvement over the Deficit Commission's plan, which called for reducing the deficit by raising tax revenue to an unprecedented 21 percent of GDP–an approach that is little more than wishful thinking on the part of its authors.

However, a look at the data shows that while the Ryan plan will cut spending the first year, it then proceeds to slow down the rate of spending. In nominal terms, spending increases from $3.6 trillion in 2011 to $4.7 trillion in 2021. That equates to a $1.1 trillion increase over that period.

Of course, you wouldn't know that anything about those spending increases under the Ryan plan if you only read the recent headlines wailing about "the end of progressive government."

All things considered, Ryan's proposal is a definite improvement over the Deficit Commission's plan to increase spending by $1.6 trillion over 10 years and it's also a big improvement over the president's budget which increases spending by $1.9 trillion over the same period.

Contributing Editor Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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  1. OK, that looks like it might actually work dude. Wow.

    http://www.Anonymous-Toolz.tk

  2. Flashing phallic banana terrorist still on the loose!

    http://www.nbr.co.nz/article/f…..e-hp-90168

    1. I salute you!

  3. Myth 2: We can’t balance the budget without raising taxes.

    It’s not merely a myth, it’s a big fucking lie.

    1. It’s freakin’ obvious that the big issue is spending more money than we have or can afford. Unbelievable how prevalent the Big Lie really is.

      1. That is not a statement of fact but opinion. So is the statement that if we want the least painful means to balancing the budget we must include some changes on the revenue side. But you guys don’t want the least painful way, you want one that satisfies your ideological bullshit.

        1. Tony|4.8.11 @ 5:19PM|#
          “…if we want the least painful means to balancing the budget we must include some changes on the revenue side…”

          The least painful for Tony, since he seems to be sucking at the public trough.
          For those who earn a living? Nope.

          1. How about “just” taxes, the way it has been working is you hire a lobbyists to bribe a politico to add a rider to some bill that benefits your company, that’s why the tax law is so huge. GE employ’s over 900 tax lawyers and gets a tax rebate.

        2. Least painful? Screw the politicos pain!

          People are being layed off, their houses are worth 60% as much and food/gas prices are going up.

          And then ignorants like yourself want to RAISE TAXES.

      2. C’mon, Tony’s right! All we have to do is print a hundred trillion dollars or so of new money. Presto! Debt problem solved!

        1. But there’s no reason to pay off the debt right away. All that new money could fund one doozy of a high-speed rail system. We can print more money later if we want to pay off the debt.

          1. We’re gonna need bigger trains to carry all that freshly printed money around the country, not to mention the ink and paper that go into it.

    2. You are right of course, but why is that so hard for some to see. It is elementary.

  4. “Spending Under DeRugy – Gillespie”

    Does that mean de Rugy will be on the top of the presidential ticket over Gillespie in 2012?

    Also, as lovely as Veronique is, they need to leave her graphs on screen while she’s explaining them.

  5. Yeah. Spending cuts. Great. How about we completely and totally obliterate and eliminate 90% of the federal government, confine it strictly to its few, enumerated, limited constitutional and morally justifiable powers, and then proceed to do the same with states and local governments?

    How does that sound? Sounds fucking great to me. Where the shit are the constitutionalists and libertarians? Yeah, that’s what I thought. “Silent MAJORITY” my ass.

    1. Don’t be silly.

  6. Isn’t Veronique tired of being the token cunt?

    1. So your mom’s name is Veronique too?

    2. Max|4.8.11 @ 4:52PM|#
      “Isn’t Veronique tired of being the token cunt?”

      Isn’t Max tired of being the token shit-head?

      1. Nope…it’s what I do best.

        1. Max|4.9.11 @ 2:52PM|#
          “Nope…it’s what I do best.”

          Not only that, but it’s the *only* thing you do.

  7. Outrage After Officer Pepper Sprays Baby Squirrel

    MESQUITE, Texas – A YouTube video of a police officer using pepper spray on a baby squirrel has sparked outrage in the city of Mesquite, Tx.

    A student recorded the incident. In the video, the officer is seen spraying the animal after it began chasing students around at Kimbrough Middle School.

    Students are heard begging the cop, reffered to as Officer Davis on the video, to stop with cries of “No!” and “Don’t spray him!”

    Mesquite Police Department has defended the officer’s actions.

    http://www.myfoxny.com/dpp/new…..110408-ncx

    1. “Sgt. Wes Talley said the officer stood between a group of students and the animal because he thought it may have been rabid.

      Talley said after several unsuccessful attempts to scare the squirrel away, the officer used his pepper spray on it to protect the welfare of the students.

      One parent questioned why the students weren’t simply moved away from the squirrel.”

      1. Why didn’t the stupid fuck shoot it with his .38 or better yet his tactical 12 ga. It could have gone crazy and killed the whole town!

  8. Of course there is Shikha. But aren’t there any native-born right-wing libertarian cunts? The right-wing masses aren’t wild about accents.

    1. Wow! You’re as dumb as a used tampon!

      1. So you could say a tampon is the smartest thing to come out of Max’s mom’s cunt.

        1. That assumes she uses feminine hygiene products.

          1. “That assumes she uses feminine hygiene products.”

            She obviously did! What do you think Max is?

            1. The best part of Max ran down his mother’s leg when he was born.

          2. I believe Max exited the adjacent hole.

  9. I think we need to start talking differently about the size of the debt and unfunded liabilities so it sinks into the general public to whom numbers in the $trillions are too abstract.
    Federal government will need >$1 million per household to pay its IOUs!
    > $116 trillion =”official” debt plus money  short for future social security, medicare, etc
    Even its “official debt” of $14.2 trillion  is $123,754 per household!
    Details at http://StopNationalDebt.com
    Facebook at http://www.facebook.com/pages/…..0177811775

    1. uhhh, you might want to go back to 4th grade math and learn to divide.

  10. Please go to http://www.votizen.com/ which lets registered voters contact their congressmen (it confirms the voter registration info so they know its likely coming from a real constituent vs. a spam bot). Tell them to balance the budget *now*, that $1million per household to pay federal IOUs is too much! http://www.StopNationalDebt.com links to it, so tell everyone to visit there! Another site linked from there lets you find direct email/contact forms (this site doesn’t let me post 2 links, though actually I can say ContactingTheCongress Org and its not a link).

    1. Fuck off, Asscunt.

  11. Mr. Chait, drumroll, please…

    1. Oh, goody!
      An abstruse, irrelevant reference which I guess is intended to show Danny is, well, half as clever as Danny believes.

      1. Nice use of “abstruse”!!

        *applauds*

    2. …while I get pegged by a circus bear.

  12. “there is a wide academic consensus that spending cuts are a major factor for achieving lasting debt reduction.”

    So, let me get this straight. If I have a high credit card debt of say $25,000 and I…um, stop spending so damned much, I’ll have a good impact on my debt problems????

    God damned them academics, is there anything they don’t know?

    Seriously, though. This is something you need academics to reach a consensus on? What’s next? An academic consensus that holding an umbrella over one’s head has a lasting impact on not getting wet in the rain?

    1. We’ll let you know once we get the government funding.

  13. All of these plans that simply slow down the increase of US government spending are not going far enough.

    Cutting back US government spending to 2007 levels plus an adjustment for inflation (around 2.7 trillion) should be no problem.

    1. This latest pissing match “cut” the budget $40 billion….that is $60 billion less than the Republicans promised. Gee it kind of seems like nothing has changed.

      1. Obviously both TEAM BLUE and TEAM RED want a huge Federal government. They just have to pay off different campaign contributors.

  14. What is independent about the Enterprise Institute? It is a conservative organization. Of course they found “facts” that support spending cuts over increased taxes. Please try to be honest.

    1. So do you have a mathematical and historical refutation of their assertions, taking current economic realities into account, or did you just feel like chimping out all over the internet today?

      1. “What is independent about the Enterprise Institute? It is a conservative organization.”
        Which means they’re independent of either of the main parties.

        “Of course they found “facts” that support spending cuts over increased taxes.”
        And it’s up to you to refute those “facts” if you want to use scare quotes; care to do so?

        “Please try to be honest.”
        You should listen to your own advice.

        1. Which means they’re independent of either of the main parties.

          That’s a fairly naive definition. By it, Exxon and Greenpeace are independent. A thousand organizations and businesses that clearly align themselves left/right.

          I think what’s generally implied by “independent” is that their backers do not stand to gain directly/financially from the (applied) research of the organization, and thus the science [very soft science, in this case] would not be subject to undue influence or obscured motivations.

          In this case, the corporate and wealthy (oil) backers of the AEI would stand to save billions of dollars if they could convince the government to cut spending rather than raise taxes.
          This means that their research must necessarily be subject to more suspicion and scrutiny than a study, say, from Harvard. The AEI research may indeed be valid, but it generally shouldn’t gain the benefit of such a presumption.

          Which is why I say below that I’m grateful the author included secondary sources.

      2. Uh, the earlier comment aimed at GL, not R R R.

  15. An independent analysis performed by the American Enterprise Institute

    The AEI is independent of government, but is partisan/right and dependent on corporations, specifically oil corporations. Their conclusions are generally going to be in line with their investors’ interests.

    I’m glad de Rugy also included a Harvard study (the first link doesn’t really work, as such, but the second does) that appears to reach similar conclusions, and not rely solely on AEI. More than one source is always a good idea (are you listening, Stossel) but in this case, it’s especially appreciated.

  16. Thanks for your share,thanks a lot.Good luck!

  17. This study is deeply flawed. Since tax rates were abnormally high after WW2 there was only one way to go. We had here in the US a top tax rate of over 90%, Kennedy lowered that rate to 70% until Reagan lowered them. Taxes in Europe have similarly only gone down.

    Now, lets look at something many of you know, the Laffer curve. It doesn’t show what many have tried to use it. But, there is no doubt a sweet spot, meaning that there is a level where taxes can get too low or too high. It’s not a flat line where lowering taxes is all good. Lower taxes to zero, many of you would suggest that zero taxes would yield greater gov’t revenues.

    So, in short, this study is of zero value without controlling for various tax rates. If taxes are much over 50% I imagine that they will give diminishing returns. Similarly, if taxes are too low, lowering them won’t help.

    Consider corporate coffers are at all time highs. “If history tells us anything, that’s unlikely. The effective corporate tax rate has been steadily declining for decades. Corporations paid more than 49% of their profits in federal taxes in the 1950s, 38% in the 1960s, 33% in the 1970s and 25% in the 1980s. All the while, U.S. wages have been stagnant for years even as productivity has risen. Between 1989 and 2010, U.S. productivity grew by 62.5% — far outpacing wages, which grew by only 12% during the same period, according to a March 2011 study by the Economic Policy Institute.”

    One principle of a flat tax is that taxes need to be flat across the economy, as money will flow out at the lowest bar.

    Finally, high taxes drive investment and hiring and low taxes discourage capital investment and hiring. For high taxes mean there’s a high discount for investment and hiring, as these are costs of business and deducted from profits.

  18. Milquetoast Republican Husband:
    Honey, at the rate you’re spending, we will owe more than we annually earn by the end of next year! We have to think about kicking our 3 unemployed kids out of the house and stop paying their car payments…c’mon they’re over 30 years old!

    Shrewish Democrat Wife:
    Fuck you, you heartless greedy bastard! You keep working overtime and depositing checks or I’ll tell the kids you hate them, and you wish they were dead!

    Republican Husband:
    Yes, dear, sorry I brought it up. Now I’ll go get your chocolates and bring them to you in bed before I go to work.

    Democrat Wife:
    And hurry the fuck up about it! Selfish asshole!

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  21. Of course they found “facts” that support spending cuts over increased taxes.

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