In light of the president’s press conference, in which he renewed his call for a “balanced approach” to replace sequestration — meaning more tax revenue in exchange for little to no spending cuts — I recommend reading this post by Stanford University’s John Taylor over at Economics One. He argues that sequester cuts should go through with the recommendation that “agencies, including defense agencies, the flexibility to adjust their budgets within the overall sequester totals.” That flexibility would allow agencies to prioritize and more effectively handle sequestration.
Taylor also highlights data from the Congressional Budget Office (CBO)’s newest report and notes that the FY2013 cuts are not $85 billion, as many people claims they are, but rather they amount to $42 billion or only 0.26% of GDP. Taylor writes:
Note that the reduction for 2013—the year currently under discussion—is very small relative to all the other changes in the budget during the quarter century period shown in the graph. It amounts to only 0.26% of GDP or $42 billion according to CBO. This is less than half the frequently mentioned $85 billion in Budget Authority because it takes time to bring about the outlay reductions. The reduction is also quite gradual, much more gradual than the sudden rise in spending in the past few years, and, with flexibility granted to government agencies, does not have to be draconian. The Administration and Congress agreed to roughly this amount of budget deficit reduction way back in 2011.Note also that the reduction for this year should be viewed as a modest installment on an overall long-term strategy to bring the federal spending share down to levels consistent with balancing the budget. We do not yet know what that strategy will be because the Administration has not submitted a budget and thus the Congress has not submitted budget resolutions.
According to the CBO’s February 2013 report on the budget outlook, “Discretionary outlays will drop by $35 billion and mandatory spending will be reduced by $9 billion this year as a direct result of [the sequester]; additional reductions in outlays attributable to the cuts in 2013 funding will occur in later years.”
Here is a chart of the ten-year impact of sequestration on spending:
The bottom line is that sequestration should go through, hopefully with allowances for flexibility, though that still won’t amount to enough spending cuts. Taylor would like to see spending reductions that put us on what is labelled “pro-growth reform” on the above chart. Spending would still be growing, but at a significantly lower rate than the current CBO baseline and spending without sequestration. This “fiscal consolidation strategy,” Taylor argues, would reduced the debt-to-GDP ratio and bring spending as a share of GDP back to pre-crisis levels. We would have both fiscal responsibility and economic growth. Reporting on his work on the subject with John Cogan, Volker Wieland, and Maik Wolters, he explains:
Our initial findings, reported here, are that this strategy has a positive impact of GDP, in both the short run and the long run. The positive short run economic effects occur even in the model with price and wage rigidities for several reasons including that the lower spending (as a share of GDP) can reduce expected tax rates and raise permanent after-tax income compared to what would be expected under current policy. This stimulates consumption. The gradual nature of the government spending reduction, which allows time for private spending to adjust, avoids the negative aggregate demand effects that traditional Keynesian models emphasize.
The whole thing is here.