Reducing Government Spending to Pay for Hurricane Relief Also Reduces GDP

The main thrust of this article is that Democrat Tom Harkin and Republican Charles Grassley, both of Iowa, disagree on how to pay for Katrina, but I didn’t think it was news that a Democrat and a Republican disagree on this point. Instead, it’s time to correct something. It’s said again and again, and this is the latest example, that we can’t raise taxes because that might hurt the economy’s recovery from Katrina and now Rita, so we will have to cut programs to pay for the spending instead. How is it that cutting government spending doesn’t reduce aggregate demand and GDP and hurt the economy in the same way as raising taxes?

Lawmakers differ on how to pay for relief efforts, by Aimee Tabor, The Hawk Eye: ...Grassley said he doesn't feel a tax increase is the solution for the Katrina relief. "If you raise taxes enough to pay for Katrina you'd probably add to the negative ripple effect that Katrina is having on the economy," Grassley said. "We don't want to compound that by an irresponsible increase in taxes." Congress then has two choices — it can either continue to borrow or cut spending, Grassley said...

First, during the recovery period itself, there is no need to do either, something Grassley seems to implicitly acknowledge elsewhere in his remarks. If the goal is to stimulate the economy during this period, then deficit spending (borrowing) is needed. Offsetting spending on hurricane relief with reduced spending elsewhere or increasing taxes does not provide any short-run stimulus. Arguments about long-run economic growth and tax rates are being mixed up with arguments about the level of GDP in the short-run.  Once the economy has recovered, then it’s time to pay the bills. At that point either an increase in taxes or decrease in spending can be used in theory since both reduce the deficit, though in reality tax increases will be needed since spending cuts alone cannot solve our deficit problem. This is where growth considerations come into play and, though there are certainly pockets of fat in government, cuts in spending large enough to dent the deficit will reduce essential spending on infrastructure and social insurance programs and harm rather than enhance our long-run growth prospects and economic security.

Comments

[cl]

Excellent post. I guess it finally took an economist to straighten these folks out.

[Mark Sullivan]

Once the economy recovers we can pay the bills? If there's a major hurricane every year for the next twenty, does that mean that we never have to pay for any of them?

There's two issues here. First, at what point does hurricane become a normal fact of life in doing business in the gulf. We don't grow alfalfa in the desert (well, most of the desert). Should we rebuild houses on the gulf coast every year? It's important in this stimulus argument because if people don't build houses in the flood zone, there won't be any rebuilding to do. No extra spending, no reason for the southerner's countrymen to go into debt so they can rebuild their houses on the beach every year. Rebuild every year and we have new spending on every hurricane. At some point it isnt "stimulative spending" but wasted money.

The second and in my view more important issue is if there's a crisis every year, can we stimulate the economy by deficit spending forever? As I understand it, keynes argued that stimulative spending was a temporary measure. A recession, then a war, then a hurricane. It's been an emergency every year since bush took office.

If there's an emergency every year for ten years or twenty, can we continue to succesfully stimulate the economy with deficit spending? If so, why have taxes at all? Just deficit spend until, well, the first year after we can't declare that there's an emergency any more.

Answer carefully. The bushies are looking for a new treasury secretary.

[Mark Thoma]

Happy to answer. I said *if* the goal is to stimulate the economy. I took the policy goal as given, then asked whether the policy they proposed would attain it. Cutting spending in other areas is inconsistent with stimulative policy.

Yes, we should budget for the mean disaster. In the less than average disaster years, we save, in the more than average disaster years, we borrow. This is a more than average disaster year, so we borrow, pay back when things are better than average. That doesn't run deficits forever. I had a rcent post on this very issue. I should have made clear that all of this is around such averages or natural rates...

Oh, and I didn't know they were looking for a new Secretary for certain. Are you applying? -:)

[Mark Sullivan]

My note sounded testier this morning than I intended last night, but thanks for answering. Good point about taking the policy goal as a given. I should've been paying more attention.

You may have to wait for a change of administration before being appointed secretary of the treasury, even if they decide to dump Snow again. I'm not an economist or a republican, but I did apply. Mentioned in the cover letter that my research showed that tax cuts would prevent future hurricanes, so I think I have a fighting chance. Keep an eye out for the press conference.

[pgl]

I read Bill Polley's blog commenting on this post and was not sure what Bill's point was. But this post was the perfect rebuttal to the latest nonsense from Robert Novak - see the update to my Operation Offset post over at Angrybear. Well done Mark!

[Mark Thoma]

Mark - I appreciated the comment, don't worry if it was edgy, the Secretary comment gave me a good laugh. It also gave me a chance to elaborate a bit.