The two parts of deficit reduction

Deficit reduction needs to address two distinct issues that seem to often get fuzzed together in current media and politician speak.

1.  How to do it - what mix of taxes and spending cuts can accomplish the desired reduction.

The Bi-Partisan Simpson-Bowles Commission Report published in December 2010, after extensive study concluded the budget could not be balanced on spending cuts alone.  A problem is many Republican's have signed a no new taxes pledge.  So their deficit reduction plans have refused to even consider revenue increases of any kind.  

But the bigger problem is issue 2.

2.  What will be the economic impact of the particular mix chosen.

The Republican bottom line non-negotiable position of no new revenues is economic suicide.  It would have been great if they were this serious about cutting spending in 2003 or so when they were cutting taxes and the economy was reasonably healthy.  But their current obsession with big cuts in spending with no new taxes is like breaking a leg to cure a limp.   

The Economist July 16 issue, page 79, has a survey of what has happened historically when big cuts in public expenditures are made during a period of economic weakness.   The article discusses a recent study that looked at 173 policy changes in rich world economies between 1978 and 2009.  The study found cutting budgets consistently resulted in a drop in GDP and a rise in unemployment.  Is that really what we want to accomplish at the current time?   The few rare occasions where the cuts in government spending were followed by an economic upturn were in countries with really high interest rates - the exact opposite of our current situation.  It makes sense in that situation because when Government stops borrowing it lowered demand so interest rates drop - making money more available to business and consumers.  Couldn't be more inapplicable to our current situation where our interest rates are practically at zero.   

A classic example that it is a poor idea to start chopping at Government spending during serious downturn is the Great Depression.  In the mid-1930's as the US was beginning to crawl out of the worst depths of the depression deficit hawks talked Congress into big cuts in Government spending.  The stock market crashed again and the economy stalled.  Luckily (?) WW II came along a few years later to jump start our climb out of our economic doldrums with massive amounts of Government spending..