Job-Killing Spending Cuts

By :: July 15th, 2011

There has been a lot of talk in Washington recently about “job-killing tax increases.” Raising taxes, the argument goes, would lead businesses to hire fewer workers and stifle our already weak economic recovery. But I haven’t heard anyone talking about “job-killing spending cuts.”

In macroeconomic terms, tax increases and spending cuts have qualitatively the same effect on the economy (but the quantitative impact could differ, depending on incentive and efficiency effects). Both reduce aggregate demand for goods and services. A dollar taken in tax means taxpayers will spend less. A dollar reduction in government transfer payments means recipients will spend less. A dollar less government spending on goods and services cuts demand directly. If anything, cutting government purchases lowers demand more than an equal-dollar tax increase because the former reduces demand dollar-for-dollar while some of higher tax payments will come from savings, thus tempering the drop in demand. (Reduced transfers also have a smaller effect because beneficiaries will use savings to offset some of the lost income.) And, of course, the biggest impact on jobs comes when cutting spending means laying off teachers and other government workers.

The Congressional Budget Office yesterday issued a report discussing the short- and intermediate/long-run effects of reducing the deficit. The bottom line for the short-run:

In the short term, while the economy is relatively weak and economic growth is restrained primarily by a shortfall in demand for goods and services, the reduction in federal spending or increases in taxes that would produce smaller deficits would decrease the demand for goods and services even further and thus reduce economic output and income. (p. 3)

More specifically, CBO concluded that cutting spending and increasing taxes enough to reduce the federal budget deficit by $2 trillion over the next decade (ramped up from $100B in 2012 to $300B by 2021) would reduce real GDP by between 0.1 percent and 0.6 percent in the next three years, “depending on the year and the assumptions used.” In the longer run, reduced deficits would increase GDP because individuals and businesses would save and invest more.

CBO did not assume any particular combination of spending cuts and tax increases used to reduce the deficit. That choice would affect how much a particular policy would reduce GDP in the short run but not the basic fact that either approach to deficit reduction would harm the economy over the next few years.

I don’t like politicians using the pejorative term “job-killing” to describe any economic policy. The term works in sound bites but makes serious discussion more difficult. But if people are going to use the term in discussions of deficit reduction, they should apply it equally to both tax increases and spending cuts.