(Arthur B. Laffer) – Addressing the possibility of the GOP-led Congress not voting to raise the debt ceiling, Austan Goolsbee, President Obama’s top economic adviser, histrionically asserted this month: “This is not a game. The debt ceiling is not something to toy with. If we hit the debt ceiling, that’s . . . essentially defaulting on our obligations, which is totally unprecedented in American history. The impact on the economy would be catastrophic.”
In context, his comments are more than a bit hypocritical. Over the past four years—including the last two years of the Bush presidency—he and his boss supported every big, misguided spending program they could find, regardless of how much the electorate protested. There wasn’t a dollar that didn’t burn a hole in their pocket.
They supported add-ons to the housing and farm bills in 2007 to stimulate the economy; Larry Summers’s $600 per-capita stimulus checks of 2008; the bailout of AIG, the Fed’s asset swaps with Bear Stearns; the $700 billion Toxic Asset Relief Program; Mr. Obama’s nearly $900 billion stimulus package; the total government takeover of Fannie Mae and Freddie Mac; the temporary cash-for-clunkers program; the $8,000 temporary home-buyers’ tax credit; the extension of unemployment benefits to 99 weeks; the Dodd-Frank financial reforms; and of course the Patient Protection and Affordable Care Act (aka ObamaCare).
Not only did Mr. Obama and Senate Majority Leader Harry Reid support all of the above government spending, they also voted against raising the debt ceiling in 2006 when George W. Bush was president and the Republicans controlled the House and Senate.
Here’s what Mr. Obama said on the Senate floor then: “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. Leadership means that ‘the buck stops here.’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better. I therefore intend to oppose the effort to increase America’s debt limit.”
Mr. Reid gave a similar speech: “If my Republican friends believe that increasing our debt by almost $800 billion today and more than $3 trillion over the last five years is the right thing to do, they should be upfront about it. They should explain why they think more debt is good for the economy. . . . Democrats won’t be making arguments to support this legislation, which will weaken our country.”
Now the roles are reversed. In March, the debt ceiling of $14.3 trillion is going to be hit. Today’s debt number is about $13.9 trillion and rising faster than a jack rabbit. Mr. Goolsbee is correct that it would be a mistake to use the debt ceiling as the means to control Mr. Obama’s spendthrift ways. But there is no reason why House Republicans shouldn’t seek and get major concessions from the Democrats in exchange for raising the debt ceiling.
There are, for example, many truly bad provisions in the Dodd-Frank financial-reform law and the president’s health-care legislation that should and could be repealed. The Republicans should target these provisions for repeal and attach them to the bill to raise the debt ceiling. Once the bill containing items to be repealed passes the House, it would likely also pass the Senate. Who among the 21 Democrats and two independents whose terms are up in 2012 would vote against raising the debt ceiling, especially if the legislation also removed the least-popular features of other bills? Once passed by the full Congress, it’s even less likely that Mr. Obama would veto it.
But just because the debt ceiling should be raised on this occasion does not mean that the logic behind Mr. Goolsbee’s argument—that not doing so would be “catastrophic” for the economy—is accurate. On the contrary, cutting spending and cutting it drastically would not hurt the economy. It would, in fact, help the economy, even if done now.
Imagine there are only two farmers who make up the whole economy—Farmer Jones and Farmer Smith. If Farmer Smith receives unemployment benefits, who do you think pays for those unemployment benefits? Farmer Jones is the correct answer.
Government spending is taxation, pure and simple. That taxation reduces output, employment and production. It’s basic Econ 101. If, instead of using government spending for productive purposes, Congress uses it on bailouts for failing banks and unprofitable businesses, cash for clunkers, housing subsidies and unemployment, it’s a double-whammy for the economy. You can’t raise taxes on people who work, increase what you pay people not to work, and then expect more people to work.
The mistake Mr. Goolsbee makes when he says that a massive reduction in government spending will reduce output is to confuse accounting with economics. In the simplest accounting terms, GDP is equal to consumption plus investment plus government spending—that’s true. But reducing government spending doesn’t reduce GDP dollar-for-dollar, as this accounting equation would seem to be saying.
Reducing government spending is not only a reduction in one of the components of GDP, but it is also a reduction in effective taxation and a reduction in payments for non-work and less output. In due course, cutting government spending will increase private output (in this case consumption plus investment) by more than the reduction in government spending.
After World War II, the U.S. cut federal government spending dramatically. In 1945, federal government spending as a share of GDP peaked at 31.6%, and by 1948 it was down to 14.4%. Private real GDP (e.g., GDP less government purchases) for the three years 1946, 1947 and 1948 grew at a 7.5% annual rate. So much for the idea that cutting government spending hurts the economy.
President Clinton also cut federal government spending as a share of GDP by over four percentage points, to 18.8% in 2000 from 22.9% in 1992—more than the next four best presidents combined. We all remember the prosperity of Mr. Clinton’s eight years in office. I could go on and on, but the simple fact is that cutting government spending stimulates the economy. My fervent wish would be to have Mr. Obama be more like Mr. Clinton. As it stands now, they couldn’t be more diametrically opposed.
(Mr. Laffer is the chairman of Laffer Associates and co-author of “Return to Prosperity: How America Can Regain Its Economic Superpower Status.” This column originally appeared in the Wall Street Journal)