Stimulus, R.I.P.

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Most criticism of the impending federal budget cuts–the “sequester”–focus on their clumsiness. They hit a wide range of defense and domestic programs, with no rational prioritization except for what particular agencies can come up with on short notice. Opinions differ on the larger question of whether cuts of this magnitude are wise at this time. Supporters say that the cuts only amount to about 2% of the federal budget, and it’s high time we tackled the federal deficit. Critics point out that the exemption of certain areas of the budget requires larger cuts elsewhere: about 8% for defense and 5% for non-defense discretionary programs. The timing of the cuts, coming with the economy still sluggish and other stimulus measures expiring, is also a concern.

The Washington Post’s Wonkblog has an excellent factsheet on the sequester. The Budget Control Act of 2011 required these cuts to go into effect unless the Joint Select Committee on Deficit Reduction (the “supercommittee”) reached a bipartisan agreement on deficit reduction. The cuts were intended to be drastic enough to force a budget compromise. Compromise failed when the Republicans on the committee refused to consider any tax increases. The cuts fall equally on defense and non-defense spending. Most of the non-defense cuts come from discretionary programs, since “mandatory” programs like Social Security are protected. Other protected programs are Medicaid, SNAP (food stamps) and TANF (Temporary Assistance to Needy Families). Medicare gets only a 2% cut in payments to providers. Beyond that, the cuts don’t distinguish between more essential and less essential programs. They hit military operations, disease control, border and airport security, disaster relief, public housing, food and drug safety, federal prisons, and just about everything else. Two of the most inconvenient consequences at this time are reductions in unemployment compensation for the long-term unemployed and a smaller SEC budget at a time when Dodd-Frank has expanded the agency’s regulatory responsibilities.

Jared Bernstein has a good chart from Moody’s Analytics showing the estimated impact of changes in fiscal policy on GDP growth. The two biggest federal contributions to GDP growth were the American Recovery and Reinvestment Act of 2010–the “stimulus”–and the cut in payroll taxes begun in 2011. The phasing out of the first since 2011 and the termination of the second at the end of 2012 have already changed fiscal policy from a net stimulus to a net drag on growth. Higher taxes on incomes over $400,000 detract a little too, although not as much. In that context, the sequester should take another bite out of economic growth and cost many jobs. (Maryland, Virginia, California and Texas are expected to be the hardest hit states, with over 100,000 job losses each.) All told, Moody’s estimates that federal fiscal policy added over 2 points to GDP growth in 2009, but will deduct at least a point in 2013. Some of the money saved with the spending cuts will be offset by lower tax revenue when the economy doesn’t grow as it otherwise would have, so even the deficit reduction may be less than expected.

This situation dramatizes the dilemma a country faces when it lives too much on debt in good times. When bad times come, it then confronts the challenge of paying down debt and stimulating the economy at the same time. The fact that the government is turning from stimulus to austerity while unemployment remains so high doesn’t bode well for a vigorous recovery. Countries like Greece, Spain and Italy are in a similar situation, only worse.

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