Will leaner government produce a second recession?

Over the last year — and particularly since November’s election — a kind of consensus has grown up around the idea that the time has come to downshift America’s public sector fast.

States from New York to California are slashing government jobs, stripping billions of dollars out of their budgets. The Republican Party wants to downsize Federal spending by $61 billion dollars over the next half-year.

There are literally 14.1 trillion reasons to shrink the government.  In the next year, our national debt will likely grow to equal one full year of GDP.  That’s scary.

Fiscal conservatives argue that the brick wall is an inch from our faces.  We hit the brakes now, hard, or we smash up.

A growing number of thinkers on the right are describing this as a moral choice.  Here’s columnist Ryan Streeter.

Moral challenges always will be harder to confront than purely economic ones. If America’s fiscal condition were purely about economics, it would be easier to fix.

But it is also inherently a moral issue that will require more from all of us than most of our elected leaders have been willing to admit.

It sounds sort of satisfying. We’ve been profligate and wasteful, and now we have to sacrifice.  We have to pay the piper.  No pain, no gain.

The problem is that big societies, and big economies, aren’t as tidy as the morals in a fable.

There’s a growing school of thought that by cutting budgets too soon and too fast, we could actually deflate the fragile economic recovery.

Worst case scenario?  We could plunge ourselves into a second deep recession, costing so many jobs, building so much demand for government services, and losing so much tax revenue that we’re right back where we started.

Only worse.

The latest salvo in this argument comes from economists who think the GOP’s austerity plan will cost 700,000 jobs over the next two years.  This from the Washington Post.

[Mark] Zandi, an architect of the 2009 stimulus package who has advised both political parties, predicts that the GOP package would reduce economic growth by 0.5 percentage points this year, and by 0.2 percentage points in 2012, resulting in 700,000 fewer jobs by the end of next year.

His report comes on the heels of a similar analysis last week by the investment bank Goldman Sachs, which predicted that the Republican spending cuts would cause even greater damage to the economy, slowing growth by as much as 2 percentage points in the second and third quarters of this year.

These cautionary voices are being overwhelmed by the political momentum in Washington, but columnists like David Leonhardt are pointing out that austerity measures in Britain and Germany appear to have stalled their economic recoveries.

“By all means,” Leonhardt wrote in the New York Times, “don’t follow the path of the Germans and the British just because it feels morally satisfying.”

Concerns about Federal spending cuts are compounded by growing evidence that cuts at the state level are already slowing the recovery in some parts of the US.  This from the Associated Press.

The clearest sign to date was a report Friday on U.S. gross domestic product for the final three months of 2010. The government lowered its growth estimate, pointing to larger-than-expected cuts by state and local governments.

The report suggested that worsening state-budget problems could hold back the recovery by putting more people out of work and reducing consumer spending.

Conservatives will point out that it’s easy to keep putting off the inevitable cuts that will have to be made to begin chipping away at deficits.  They’re right.  Both of our political parties have a terrible track record here.

So what do you think?  Is it time to take the plunge, go cold turkey?  Or should we give the economy a little more time to find its legs?

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36 Comments on “Will leaner government produce a second recession?”

  1. phahn50 says:

    Certainly in the short-run we will be worse off. Its hard to imagine how you could eliminate that many jobs and not set the economy back. The big question is whether it will also increase the deficit by sucking air out of the economy at the wrong time.

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  2. JDM says:

    A leaner government will save jobs that would have otherwise been lost if the government were not made leaner.

    Without even seeing the results, I can say right now that 3 million jobs will be saved that will have otherwise been lost if the government is not made leaner.

    I’m using the Obamascope on job counting.

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  3. If we lay off an average of 10,000 public employees per state (probably a conservative figure) in 50 states that’s a half million people out of work. They will all be eligible for unemployment benefits. Unemployment benefits come out of the states’ budgets whose UI funds are mostly, if not all, broke so they are borrowing from the feds who are trying to reduce their spending. The laid off workers will have only half or less their income so they won’t be buying much which will result in a ripple effect on retail which will have a ripple effect on manufacturing and services with more people being laid off and spending less. That doesn’t sound like good economic planning to me. We need to find a way to put people back to work, not lay off more. Of course we could revert to workhouses and debtors prisons.

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  4. Mervel says:

    Reducing aggregate demand by shrinking government spending will cause the economy to slow in the short run. The point of the “stimulus” was to increase demand by stimulating the economy through government spending. Unfortunately the federal government in my opinion should not reduce overall federal spending right now; particularly when the state governments have no choice but to slow down spending right now.

    At some point it really won’t matter what we do as the credit markets will cause us to enter a forced austerity but we are not there yet
    .

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  5. phahn50 says:

    There are several estimates out there saying that we will lose between 1 and 2 percentage from the GDP if all the GOP budget cuts are adopted. Thats a lot fewer jobs in the private sector that will be created, and a whole lot less tax revenue etc. Obviously we have to get the deficit down at some point, and it wont be painless, but now isnt the right time. I agree with Mervel on that.

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  6. oa says:

    1. GOP cuts will cost 700,000 jobs ahead of the 2012 elections, here: http://wonkroom.thinkprogress.org/2011/02/28/daniels-job-loss/
    2. GOP will blame Obama for job losses.
    3. GOP wins presidency, can go back to tax-cuts-and-subsidies-for-rich, war-and-tasers-for-the-rest economy. Not hard to figure out. Plus, kill the unions, kill, kill.

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  7. newt says:

    oa-
    Yes, No, NO.

    Maybe that is why Obama was so lame in this past campaign. I think the public is under the impression that the Republicans are now in charge, and they must deliver jobs.
    Of course they will not, and Obama can ride to victory over their failures.

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  8. Mervel says:

    GOP cuts?

    There can be no such thing as the Democrats control the White House and one House of Congress, any cuts will be Democratic cuts. Obama has been in charge and he has had a majority Democratic Congress. Today the Executive Branch and one House of Congress are Democratic he had control of all government up until the last election. You can complain about Bush you can whine about the Tea Party, but the Democrats are the Party in charge and have been since 2009. Even with this last election the Democratic Party is still in control

    The public has a correct impression of outcomes, one of the problems with many on the Left is their disdain for the public. Obama did not create the jobs he said he could and would, his policies have not worked as he said they would.

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  9. phahn50 says:

    But Mervel – The GOP is now focusing on eliminating jobs to deal with the deficit, which they now claim is the over-riding problem we face. Obama is focusing on job creation. Hopefully they can get together to get something done but at this point their efforts seem diametrically opposed.

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  10. PNElba says:

    Mervel claims “Obama did not create the jobs he said he could and would, his policies have not worked as he said they would.”

    Let’s see some proof for that statement please.

    “Without even seeing the results, I can say right now that 3 million jobs will be saved that will have otherwise been lost if the government is not made leaner.”

    Statements like the one above by JDM show the beauty of governing without the need for evidence.

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  11. Bret4207 says:

    IMO it would be wise to move slowly and deliberately with LONG TERM objectives. The problem is our politicians don;t make long term plans, they react with one thought- get re-elected and stay in power. We can lower costs through attrition and getting rid of duplication and redundant programs, waste, fraud and by closing down the Iraqui and Afghanistan projects. We can also get rid of crazy ideas like Obamacare and Cap and Tax.

    We need to stabilize our dollar, not continue to devalue it. We need to reduce costs to the consumer, taxpayer and businessman. We need to instill a realization in our population that we all need to contribute and we all need to take a bit of a hit. How we do all this is the problem.

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  12. Pete Klein says:

    Let’s have some fun with this dire situation.
    Imagine we are on a leaky boat. Water is coming in and our smart leaders decide the best way to get water out of the boat is to drill holes in it to let the water out.
    Is that a plan or what?

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  13. Walker says:

    Brian Mann writes: “It sounds sort of satisfying. We’ve been profligate and wasteful, and now we have to sacrifice. We have to pay the piper. No pain, no gain.”

    But those pushing pain and sacrifice are wealthy politicians and their wealthy supporters– they aren’t going to feel any pain at all.

    We got out of the deficits of the WW II years with a 90% top tax rate, and the economy grew and we built the Interstate Highway system. We could do it again if we could just get over the new Tax Cuts – Spending Cuts religion.

    Republicans cut taxes in order to “Starve the Beast”, remember? Now they cry “Oh my, look at that terrible deficit!”

    Cut the military budget sharply. Tax the uber-wealthy.

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  14. TurdSandwich says:

    I thought the bush tax cuts were supposed to create jobs. In reality, states are cutting jobs because of the decrease in income. I think OA has the formula that the GOP will use.

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  15. mervel says:

    So 10% unemployment in 2011 was his plan? Obama made numerous statements that if the stimulus was passed if we followed his plan unemployment would go down by now and be much lower than 10%. His economic plan is not working, poverty is increasing and this is under the Democrats not the Republicans. At some point people start measuring results not rhetoric.
    We can only blame Bush for so long, I think you could indeed blame Bush through 2009 and even into 2010, but from here on out its all Obama this is the Obama economy now. These are the Obama tax cuts now; he approved them he refused to make any sort of hard choice and get rid of them or embrace them either. He wanted it both ways to complain about them but not veto them so he owns the tax cuts.
    In the end though cutting government right now is not smart I agree with that; and I hope the President holds to his guns in not cutting government right now, but given past results there is no telling what he will do?

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  16. Pete Klein says:

    Houston, we have a problem.
    The problem is us expecting leaders to solve all our problems, be they economic, social or even religious.
    We are just poor little sheep who have lost our way and it is all someone else’s fault.

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  17. JDM says:

    The “non-partisan” GAO report is out on government “redundancy”

    According to this report, it shouldn’t be too hard a few hundred-billion and still keep the government working.

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  18. If Clapton is God, Warren Haynes is Jesus says:

    All this talk of cutting the budget is nothing but theater. Both sides are ignoring those portions of gov’t which need real cutting/reform. Those being Social Security (which really only needs serious tweeking), Medicare/Medicaid, and the biggest boon-doggle of them all, the defense budget.

    Instead they argue over 61 Billion out of a 3.7 Trillion dollar budget. It’s insulting the intelligence of anyone who has even a few brain cells in their head and who is paying even the slightest attention to the fiscal mess we find ourselves in.

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  19. Bret4207 says:

    Walker, the economy and the country post WW2 was completely different than now. I’d love to believe raising the rates on the top 2% would solve our problems, but it won’t. If you were to raise the rates on the top 25-35% then it would make a big dent, but what politician is willing to try that idea?

    Post WW2 you had room for massive projects, little concern given to environmental and social issues, few things barring BIG ideas. We had an industrial infrastructure that took the money spent on those ideas and spent it here in the us on steel, aluminum, oil products, vehicles, machinery and tooling. That paradigm doens’t exist anymore. IMO this idea that we can simply employ Keynsian economic ideas to have gov’t fund the economy with deficit spending isn’t a workable solution anymore.

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  20. Pete Klein says:

    Are we to leave the rich for last?
    What I mean is: First they went after the unions and government workers but I didn’t say anything. Then they went after those receiving Social Security and Medicare/Medicaid but I didn’t say anything.
    Get the picture?
    It seems to me that if the rich had an ounce of brains and were capable of looking down the road, they would step up to the plate now before some wise guy decides the best investment for the future is to start mass producing guilotines.
    Not hoping. Just saying.

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  21. Mervel says:

    I agree with Clapton, its all noise. Which I guess given that we are still in a huge recession is a GOOD thing.

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  22. Walker says:

    Bret, you’re right. I’ve been waiting for someone to call me on the differences, and you’ve done a good job of it. Still, it’s not at all clear to me that the differences mean that the economy would crumble if we moved the top rate seriously back in that direction. And I suspect that you’re pulling that “25-35% range out of thin air: if you have a source, please share it.

    You can’t tell me that we couldn’t make a real big dent in the deficit by cutting military spending AND raising the rates on incomes over, say, one million dollars. Then if we move to Single Payer… (I know, not in this lifetime)

    And when you say that “post WW2 you had room for massive projects,” we currently have room for the massive project of rebuilding the highway and railroad systems that we’ve been under funding for decades.

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  23. dbw says:

    I remember thinking during the “W”‘s first term that it was going to take the country decades to recover from his policies. The tax cut coupled with two large unfunded wars, along with the drug prescription plan seemed way over the top. I took my share of that tax cut and sent it to the Concord Coalition, a bipartisan group working on the deficit–It was pretty obvious where all this was going to lead. As for the wars, we have blown up billions of dollars in treasure and have little to show for it. To think that anyone could have started to turn things around within a couple years is just totally unrealistic. This is going to take a long, long time.

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  24. Bill G says:

    David Brooks’ piece in the NY Times today does a great job of addressing many of the issues discussed here. His main points are that, to be effective, the pain of the inevitable cuts that will be taking place should be shared and that they should be made with an eye on their impact on future competitiveness. In this regard, they should be skewed toward the older cohort in the population to the benefit of the young. He also soberly notes that seniors vote (for their selfish interests) and that “the future doesn’t have a union”. I think he’s got it right and that, although his analysis is on the money, politicians will take the path of least resistance which almost invariably is the wrong one.

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  25. BRFVolpe says:

    Thanks, Bill G, (from a liberal, senior, retired educator), for David Brook’s column. Spot on.

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  26. Mervel says:

    The implication of the article is more borrowing as long as we are able. This is the path of least resistance.

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  27. RationalandLogical says:

    The simple fact is recessions are a fact of economic life. Supply surges to keep pace with growing demand and when demand ebbs production recedes to compensate. This particular recession (we are NOT out of it – at best we have stabilized) is especially severe and very unique. This particular recession was borne of false and unsustainable demand created from debt. Debt that has been built to an astounding, almost unfathomable amount of borrowing – borrowing in the form of massive unsecured credit through over use of credit cards and supposedly secured debt through an inflated and overheated housing market (home equity loans and speculative real estate investment). During the boom years an associate of mine secured a home equity loan based on 150% of value of his home – astounding. These wide spread practices resulted in the financial bust of late 2008. To make matters worse our esteemed president (supposedly the smartest individual on the planet) used this financial crisis and associated public concern to replace overheated private borrowing with overheated public borrowing in a vain attempt to lessen the pain.

    As recessions are facts of economic life so is the associated pain. The path we are on now is an attempt to avoid the pain. Yey all we have done is kicked the can down the road. There will be loss of jobs (private and public). There will be high unemployment and supply will adjust back to demand created from true assets not borrowed money. Given the enormity of the problem made larger by the policy invoked by our esteemed president this will take a long time. I only feel sorry for those who retired or near retirement because these people will be the first to have to adapt to a new economic world….one not supported by building debt.

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  28. Bret4207 says:

    Walker, here is some of what I base my guess on-

    http://www.taxfoundation.org/taxdata/show/24955.html

    http://www.taxfoundation.org/taxdata/show/151.html Go to 1950 and see just what kind of rates were being paid! EVERYONE had much higher rates, cripes, the 28ish% tax bracket was for people making $4-6K a year!

    http://www.taxfoundation.org/taxdata/show/250.html The top 25% are paying over 85% of the taxes recv’d, the top 5% pay over 55% of the taxes. If you wanted to make a real dent in things like the deficit and national debt you aren’t going to get it simply by raising the rates on the top 1% (1.4 m people). OTH, you raise the rates on 35m people (the top 25%) or the top 50% (nearly 70 m people) you get a whole lot more revenue. That’s your middle class and up.

    We have a $14 TRILLION dollar National Debt http://www.usdebtclock.org/. We have a $1.5 TRILLION dollar deficit under current spending. So taxing the top 1% you’d need $1.07 million MORE from each of them just to balance the budget, if I did the math right. That’s seems a pretty unreasonable expectation to me. Even doing the top 50% you need an additional $21K from each taxpayer in that group. So it’s just not as simple as raising rates, even on the largest group. We HAVE to cut spending drastically. We have to cut defense, go to means testing on Social Security and Medicare, and cut our debt interest load. We can’t institute crazy spending like Obamacare or raise tax costs with Cap and Tax. We can’t risk another hit to an economy that already has a 10-25% UE rate, depending on which charts you believe. We can’t continue on like this.

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  29. Bret4207 says:

    Whoops, make that “We can’t risk another hit to an economy that already has a 10-25% UE rate, depending on which charts you believe, by devaluing our currency so that inflation and prices on fuel rise to obscene rates.”

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  30. Bret4207 says:

    Something that puzzle some is that some of the same people who were decrying NYS pension practices ( a union negotiated agreement) are also decrying the Wisconsin GOv for doing just what they wanted here in NY.

    ???

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  31. Bill G says:

    Since Brooks has been a strong supporter of deficit reduction a la Bowles Simpson, I believe reading a desire to keep borrowing into his position on spreading the pain is mistaken. He has been a vocal and long-standing critic of ad ministration and congressional inaction on the big issues (Med, SS, etc.). What he is favoring is a scalpel, not a meat ax.

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  32. goose says:

    I agree with what some have said regarding investing in the future (the long run). I am sure this has been the subject of many political speeches, but how much political action is really aimed at long term (often slow earning) investments? These will not produce results within the established political (re-election) cycles, and therefore are often pushed aside for stop gap measures, or one shot fixes that don’t really fix anything in the long run.

    Also mentioned above, military spending does not create jobs for us like it once did because we have farmed out production of some of these materials to China. We can’t even make money on war anymore.

    It seems to me that our only hope for reviving our economy is to start making our own clothes, shoes, electronics, furniture, etc. We can’t all be stock traders, government employees or news analysts. There has to be a much larger working class with actual work to do. The government can try to help us with this. But in the end they will be useless. We must create the demand for products made within our own towns, states and country; it wasn’t that long ago that we did. This sounds like a good idea to me, but I am not sure we are quite ready to welcome back our industrial age.

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  33. Walker says:

    Bret, given how likely this is to happen, I’m impressed that you put that much effort into working it out!

    But consider that in the US the wealthiest 10% hold 70% of the wealth, and the top 1% hold 40% of the wealth, I really don’t think you’d have to go that deep to make a big dent in the deficit, especially if you combine tax increases with a major cuts in military spending and subsidies for corporations.

    And we haven’t addressed a major issue here– the tax rate on capital gains: since much of the income of the wealthy comes in the form of capital gains, the 15% rate on such gains makes the top tax rate all but meaningless (along with many other tax shelters and dodges).

    So let’s raise the long term capital gains rate, or simply tax gains as ordinary income, and get rid of second home mortgage deductions. What do you think– are we getting there without killing off the middle class?

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  34. Bret4207 says:

    If you base your idea on “wealth” then you have a flawed premise to start with. Yes, I’m sure your numbers are pretty accurate, BUT- wealth is not income. Wealth, real money, is likely to be in investments, off shore accounts, in non-liquid assets that are immune from taxation as such. If you want to fix the problem we have to cut spending first, probably raise taxes across the board and hope the economy improves.

    If you put a bigger hit on capital gains the you shoot desire to invest in the foot. Yes, it sounds like an easy answer- take the profit from those evil rich guys. You take away the profit, you take away the reason to invest in the first place. I personally wouldn’t know what it’s like to have to worry about capital gains taxes, but common sense tells me no one is going to throw their money away.

    Hey, you want to go to a flat tax or consumption tax and get rid of most loopholes and shelters, fine with me. But you still have to address spending in a long term fashion. We let things get too big. It’s failing, no matter what we’d like to think.

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  35. Walker says:

    Bret, you might want to take a look at this 2005 NY Times article: http://www.nytimes.com/2005/06/05/national/class/HYPER-FINAL.html?ei=5088&en=f1a744d1ce38c79e&ex=1275624000&adxnnl=1&pagewanted=print&adxnnlx=1167768251-QyL5A3YKMbR1lVIFSUkYVg

    As for the danger that if you raise the capital gains tax, the rich will stop investing, ask yourself, what choice do they have? In 2005, there were 145,000 taxpayers with annual incomes over $1.6 million, averaging $3 million. You can be sure those numbers are substantially higher today.

    “Under the Bush tax cuts, the 400 taxpayers with the highest incomes – a minimum of $87 million in 2000, the last year for which the government will release such data – now pay income, Medicare and Social Security taxes amounting to virtually the same percentage of their incomes as people making $50,000 to $75,000.

    “Those earning more than $10 million a year now pay a lesser share of their income in these taxes than those making $100,000 to $200,000.”

    Again, these are 2005 numbers. These are the tax cuts we just foolishly extended.

    And I did address spending: let’s look at major cuts in military spending and subsidies for corporations.

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  36. Bret4207 says:

    Again, I have no real problem with taxing the “rich” more, of stopping the cut offs and limits after which they aren’t taxed . In fact I would have no problem with the gov’t simply seizing 90% of the assets of Oprah, the Kennedys, Gates, Jobs, every Senator and Congressman worth more than $200K, all the sports and Hollywood types, all the Wall St guys. Get rid of all the loopholes except for mortgage interest and child deductions. Just pull an FDR and take it! That still won’t solve the problem and I’m pretty sure they’d all leave the country or something similar.

    My biggest problem with this “tax the rich” idea remains that the definition of rich will fall lower and lower as revenue declines more and costs go up. Sooner or later it’ll be you and me getting the shaft for being “rich”.

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