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.