The Sequester Dilemma—How Much Is Too Much Austerity?

Financial FAQs

Come March 1, we will begin to see how much damage the sequester agreement causes. A recent CNBC column by Larry Kudlow illustrates both the misconceptions and reason for the gridlock on avoiding across-the-board spending cuts of some $85 Billion to the federal budget..

Kudlow says “Looking at the sequester in this light (only half of sequester cuts take place immediately), it's clear that it won't result in economic Armageddon. In fact, I'll make the case that any spending relief is actually pro-growth. That's right. When the government spending share of GDP declines, so does the true tax burden on the economy. As a result, more resources are left in the free-market private sector, which will promote real growth.”

In fact, GW Bush’s program of huge tax cuts that lessened the “true tax burden” while continuing government spending proved just the opposite. Pumping all that money into the private sector resulted in the slowest post-WWII growth in history, plus the Great Recession, the worst recession since the Great Depression.

Taxpayers paid for those tax cuts and wars, in other words, pushing corporations to record profits and the top 1 percent of income-earners to 121 percent of all income earned from 2009-2011. This is while incomes of the 99 percent that do most of the spending actually shrank 0.4 percent during that time, per economist Emmanuel Saez. So “real growth” wasn’t promoted, because the 1 percent hoarded their profits and paid themselves higher salaries, rather than reinvesting in the economy.

The Congressional Budget Office predicts that allowing the sequester cuts to kick in on March 1 will ultimately result in 750,000 lost jobs and subtract 0.6 percent from GDP growth. Why? Because when both the private sector and government cuts spending, there is no investment in future growth, period.

Graph: Calculated Risk

It’s actually worse than that, because unused production capacity will remain unused, which is the real casualty of a further cut in government spending. It has already been reduced some $2.35 trillion from existing legislation. Policymakers have enacted nearly $1.5 trillion in spending cuts for appropriated programs (mainly through the annual caps enacted in the 2011 Budget Control Act) and nearly $600 billion in revenue increases in ATRA, the American Tax Relief Act agreement reached in December.

The Congressional Budget Office expects the deficit to shrink from 8.7 percent of GDP in fiscal 2011 to 5.3 percent in fiscal 2013 if the sequester takes effect and to 5.5 percent if it doesn't. Either way, the two-year deficit reduction — equal to 3.4 percent of the economy if automatic budget cuts are triggered and 3.2 percent if not—would stand far above any other fiscal tightening since World War II, and could lead to another recession. For without rising household incomes, with private sector businesses that aren’t reinvesting, only the government can boost the demand for goods and services.

Harlan Green © 2013

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