Politics & Policy

What Kind of Cuts Grow the Economy?

Spending reductions must be large, credible, and politically difficult to reverse.

With the automatic spending cuts set to kick in for the federal government on March 1, the media and Keynesian economists are predicting an economic Armageddon. Remember, these are the same people who for the past four years have promised America that the only path to a strong economy is through massive federal spending. The result: one of the worst economic recoveries since World War II and higher unemployment today than when President Obama took office four years ago.

Private business investment, not the government, is the engine of job creation in America. Over the past 40 years, studies show that as federal spending grows, jobs on Main Street shrink.

#ad#The “government spending is the answer” crowd had their chance to jump-start the economy. They failed. It’s time for a proven, pro-growth approach.

In their report “Spend Less, Owe Less, Grow the Economy,” Republicans on the Joint Economic Committee examined America’s global competitors that have sophisticated economies like ours and that have struggled with rising government debt. Time and time again, economic studies have shown that countries that reduce their government deficits through spending cuts — rather than tax increases — can boost economic growth and job creation even in the short term.

Respected economists found 21 instances between 1970 and 2007 in which ten developed countries successfully reduced their debt-to-GDP ratio by 4.5 percentage points or more by relying predominantly or entirely on spending cuts. Countries that increased taxes were much less successful. When government debt shrank through spending cuts, jobs grew.

Neighboring Canada cut its debt by 12.8 percentage points of GDP between 1994 and 2006 and more than doubled its economic growth. Sweden cut spending by over 11 percent and spurred its economy to an annual growth rate of 3.4 percent. New Zealand experienced the same.

They are not alone. U.S. economists found 26 episodes in nine developed counties where reducing debt through spending cuts provided a large boost to economic growth in the first three years after their fiscal consolidation began.

So what drove these pro-growth turnarounds?

First, businesses no longer expected the government to levy large tax increases in the future to pay for excessive spending; as a result, businesses stepped up their investment in buildings, equipment, and software. Business investment, as we know, equals jobs. It’s key to a strong recovery in the U.S. Today, nearly $2 trillion of American business investment remains stranded on the sidelines.

Second, because families no longer faced higher taxes, they had higher expectations for permanent disposable income, which increased their confidence and ability to make major purchases for homes and autos.

So here’s a key question: As America’s lawmakers face the upcoming sequester, what kind of spending cuts actually grow the economy?

What we know from watching our global competitors turn their economies around is that spending reductions must be large, credible, and politically difficult to reverse once made. These are important criteria: large, credible, and politically difficult to reverse.

The design of spending cuts also matter. These four categories produce the strongest growth: right-sizing the government workforce; eliminating duplicative agencies and programs; eliminating subsidies to business; and, finally, reforming and reducing transfer payments (entitlements) to individuals.

It’s encouraging that reforms to entitlements that make them sustainable and solvent produced strong economic growth even when the reforms were phased in slowly and exempted current beneficiaries from change. That’s exactly the Republican model to save these important U.S. programs over the long haul.

The automatic spending cuts that start March 1 begin to address two of the pro-growth targets: shrinking the size of the government workforce and eliminating duplicative programs. Washington will be forced to decide which programs to fund and which are lower-priority.

Sequester does less to effectively end government transfer payments to business, and it does nothing to begin the critical task of making Social Security, Medicare, and Medicaid solvent over the long haul. But it’s a start.

Predictably, spending apologists such as Paul Krugman mistakenly point to the U.K. or Greece as failed experiments in spending restraint. But they neglect to mention that both countries simultaneously enacted significant tax increases that negated confidence in their fiscal plans. Tax increases similar to those that President Obama and congressional Democrats insist on slowed economic growth among our global competitors and will slow America’s recovery as well.

If we’re serious about getting America’s economy back on track, if we’re serious about real economic growth of 4 percent or more each year, it’s time to stop believing in the government-spending fairy.

It’s time to strengthen economic confidence so businesses will invest in new jobs again, and we can do that by reducing America’s dangerous budget deficits. It’s time to show Main Street we are finally serious about getting America’ financial house in order.

— Representative Kevin Brady (R., Texas) is the incoming chairman of the Joint Economic Committee.

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