Last week I wrote about Donald Trump’s dumbfounding decision, as the Republican frontrunner, to advocate for increasing taxes on the wealthy. I left for today commentary on the amazing interview Ohio Governor John Kasich did with the Washington Post Editorial Board. Essentially Gov. Kasich believes that we can obtain economic growth through spending cuts. (Just to be clear why this is on a tax blog: spending and taxes go together like peanut butter and jelly).
It seems most pundits are speculating that there will be a contested Republic convention in Cleveland. It has also been speculated that in that environment, a wildcard like, Gov. Kasich or Rep. Ryan, might end up the nomination. Both Gov. Kasich and Rep. Ryan appear to hold the same position that spending cuts are good. They believe that spending cuts plus tax cuts (I will address the tax cuts issue in a later post) will actually increase overall tax revenues through overall economic growth. It is not surprising that the two Republican establishment figures would hold such a belief. This principle is alignment with popular thinking: polls show many Americans think spending cuts will have an economic benefit by a 55 to 18 percent margin.
I think, therefore, it is worth exploring why spending cuts as related to growth (economic and job) is not at all mainstream economic thinking. But like all issues, here we have a complicated discussion. It may be true that spending cuts help balance the budget which may grow the economy in other dimensions. But spending in a recession, as most economic data seems to show, is the main way forward for job growth and to exit the recession. Most mainstream economists believe: (1) that spending increases job growth on a temporary basis; (2) a reduction in spending will unwind the growth back to the baseline without spending; and (3) job growth will grow the economy. However, in no way is there permanency attached to spending as related to job growth. (This is the reason that Bernie Sander’s forecasts are of job growth in his plan are incorrect. See this study.)
On the other hand, if your baseline is the recession is over, government spending as the driver for reduction in unemployment is no longer a viable model, and a balanced budget is more important to growth, then spending cuts resonate. The main rationale for elimination of spending cuts being advocated (see for example, this Heritage study), is cuts have helped reduced the deficit and the evidence of spending cuts is as a job driver is not evident. For example, Heritage uses this chart:
Does the chart show that spending reduced unemployment (the lines seem to be correlated) or does it show that spending underperformed? What makes this determination so hard is the difficulty showing causation and not merely correlation. There are too many variables to know one single factor works. (Here is a link to a paper that tries to isolate variables at the state level.) Economic research supports that spending has causal effects on temporary job growth. Once again, there is a difference between soundbites and reality.
Let’s get back to Gov. Kasich’s story and follow the Post as they set the stage.
The Post starts by asking Gov. Kasich why he does not have a detailed tax plan. His stock response to these question is that tax plans don’t matter and he sticks to the script. He says that the key to growth is a balanced budget and then moves to his talking points. He wants lower regulations on business, lower taxes (sorry Donald) and spending cuts.
The Post rightfully follows-up by stating Gov. Kasich seems to be balancing the budget through cuts. This seemingly makes sense. If you lower taxes, revenues go down. To balance the budget, you need expenses to go down also.
But Gov. Kasich pivots. He says, no, he will balance the budget by increasing economic growth (I’m guessing through his first factor). By increasing the total revenues, according to Gov. Kasich cuts won’t matter because we will have a greater pie.
That would be true if you could show that by cutting spending, cutting back regulations and lowering taxes increase growth. Gov. Kasich points to Ohio as an example of this plan working.
Unfortunately, his position is problematic for two reasons. One, Ohio is not doing as well as he claims. Two, this same toxic combination lead to the last recession and stagnate job growth. A retrenchment by the government in spending may sound great, but, in our tenuous job environment, a pullback could give back all the job growth over the last two plus years.
As Justin Wolfers stated, “[a]t a time of mass unemployment, it’s clear, the economics textbooks tell us, that this is not the right time for fiscal retrenchment.” Economists don’t agree on much, but, they do on this point. Although, this plan may sound like it makes sense, as part of an economic driver, it is a disaster.
We may have finally have made it past the effects of the sequester. The housing market is recovering and consumption is higher. But If government spending stops, the economy and the private sector will shrink. I am not comfortable that the economy has fully recovered that we can leave the job stabilization to the market. I may be wrong (I often am), but the alternative is a welcome back to 2008!
The Surly Subgroup 