Nips and Tucks and Big Budget Cuts
By TYLER COWEN
Published: February 2, 2013
UNLESS lawmakers act by March 1, the budget sequestration
process will start cutting government spending automatically — reductions that would amount to $1.2 trillion by 2021. Congress and the White House agreed in 2011 to the sequestration, and many people see it as a kind of political gimmick.
But I believe that it can turn out to be a very good thing — and that most of these cuts should proceed on schedule, though with some restructuring along the way.
One common argument against letting this process run its course is a Keynesian claim — namely, that cuts or slowdowns in government spending can throw an economy into recession by lowering total demand for goods and services. Nonetheless, spending cuts of the right kind can help an economy.
Half of the sequestration would apply to the military budget, an area where most cuts would probably enhance rather than damage future growth. Reducing the defense budget by about $55 billion a year, the sum at stake, would most likely mean fewer engineers and scientists inventing weaponry and more of them producing for consumers.
In the short run, lower military spending would lower gross domestic product, because the workers and resources in those areas wouldn’t be immediately re-employed. Still, that wouldn’t mean lower living standards for ordinary Americans, because most military spending does not provide us with direct private consumption.
To be sure, lower military spending might bring future problems, like an erosion of the nation’s long-term global influence. But then we are back to standard foreign policy questions about how much to spend on the military — and the Keynesian argument is effectively off the table.
On a practical note, the military cuts would have to be defined relative to a baseline, which already specifies spending increases. So the “cuts” in the sequestration would still lead to higher nominal military spending and roughly flat inflation-adjusted spending across the next 10 years. That is hardly unilateral disarmament, given that the United States accounts for about half of global military spending. And in a time when some belt-tightening will undoubtedly be required, that seems a manageable degree of restraint.
The other half of sequestration would apply to domestic discretionary spending, where the Keynesian argument against spending cuts has more force.
But here, too, much of the affected spending should be cut anyhow. Farm support programs would be a major target, and most economists agree that those payments should be abolished or pared back significantly. Regulatory agencies would also lose funds, but instead of across-the-board cuts, we could give these agencies the choice of cutting their least valuable programs — or, for that matter, we could cut farm subsidies even further.
Of course, much discretionary spending goes toward useful projects — building or repairing roads, for example, or research toward medical innovation. Limiting these investments would bring the Keynesian argument into play, and perhaps harm productivity, too. So we should look to substitute some areas for others — and turn to Keynesian macroeconomics for guidance.
THE Keynesian argument suggests that spending cuts do the least harm in economic sectors where demand is high relative to supply. Thus, the obvious candidate for the domestic economy is health care, and the sequestration would cut many Medicare reimbursement rates by 2 percent. We could go ahead with those cuts or even deepen them, because America has had significant health care cost inflation for decades.
We already have huge demand in our health care system, along with a corresponding shortage of doctors. And the coverage extension in the Affordable Care Act will add to the strain. In this setting, cutting Medicare reimbursement rates wouldn’t result in fewer health care services over all. Yes, doctors might be less keen to serve Medicare patients but might be more available for others, including the poor and the young. In the long run, the improved access for those groups would yield much return on investment, and would move the health care system closer to many of the European models.
In any case, these Medicare cuts would be unlikely to bring a macroeconomic debacle, and would ease long-term fiscal pressures. We could address the shortage of doctors by removing some barriers to entry into the profession, and, in possible new legislation for immigration, easing the way for more medical professionals to come to the United States.
Most generally, there is an issue of global investor perceptions. As the credit rating agencies have noted
, some investors wonder whether spending cuts of any kind are possible in the nation’s current political environment. And even if the economic recovery is causing budget deficits to shrink, there are plenty of negative signals about our political ability to address longer-term fiscal concerns, which will become more severe as the population ages.
Simply accepting the automatic spending cuts of the sequestration, without modification, could look like more dysfunctional politics, too. Though many of the reductions have merit, others need orderly renegotiation so the resulting cuts aren’t just necessary acts of fiscal restraint, but also net pluses for the economy.