The Flaws of Schumernomics

by Douglas Holtz-Eakin

Sen. Charles Schumer, Democrat from Keynesville, is making a big stir, claiming that the House-passed continuing resolution is a grievous threat to U.S. economic growth because it dares to pare back the bloated budget. Let’s take a look at the facts.

The first thing to note is that a reduction of $61 billion in budget authority —  which is what the appropriations process controls — does not translate into an immediate $61 billion cut in outlays. Just as it takes a long time for money to get out of the federal government (see: shovel-ready projects), there is a lag in spending slowdowns as well. On average, a $1 cut would translate into only 52 cents during the current fiscal year.

In the interests of assuming the maximum possible impact, let’s assume that a full $32 billion in reduced spending would occur in FY 2011 (i.e., before September 30), even though Democrats have never produced a FY 2011 budget and there are only seven months left. For simplicity, suppose that outlays fall by $16 billion in the 2nd quarter, $16 billion in the 3rd quarter, and — to really play fair — another $16 billion in the 4th quarter of calendar 2011.

What happens? If you thought that growth in 2011 would be 3.0 percent, if falls to 2.7 percent. That is, the largest possible impact is 0.3 percentage points. And even that continues to overstate the likely impact because:

— The calculation assumes full dollar-for-dollar reduction in GDP as spending declines. This is too large, especially because …

— Not all outlay reductions are actual cuts in the purchases of goods and services (which contribute to measured GDP). Instead, some are transfers payments to states or individuals that will have a more muted impact.

— Not all of the budget-authority cuts are from new spending. Instead, some are rescissions of the authority for spending that never occurred and might never occur. Only in a parallel universe (like the state of New York) would cutting non-existent activities constitute a penalty against growth.

— Most importantly, this is a static calculation that assumes no beneficial offset in private-sector spending due to the improved budget outlook and the prospect of lower future taxes and interests rates. Put differently, Schumernomics ignores the rationale for making these beneficial cuts to begin with: to clear the way for private-sector jobs and growth.

So, as liberals attempt fan the flames of panic, it is useful to do the math and see how overstated the argument is. Indeed, the potential impact is smaller than the typical rounding error in estimating GDP to begin with.

Finally, one could get an impact as large as 1.7 percentages points in a single quarter’s estimated growth if the full $61 billion was attributed to one quarter and the same assumptions outlined above were continued. It is exactly this kind of misguided and short-sighted policy thinking that produced the problems we face today.

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