By John F. Cogan and John B. Taylor
This week the House of Representatives will vote on its Budget Committee plan, which would bring federal finances into balance by 2023. The plan would do so by gradually slowing the growth in federal spending without raising taxes.
Still, the plan has been denounced by naysayers who assert that it would harm the economic recovery and that, at the least, any spending reductions should be put off until later. This thinking is just as wrong now as it was in the 1970s.
According to our research, the spending restraint and balanced-budget parts of the House Budget Committee plan would boost the economy immediately. With the Budget Committee's proposed tax reform included, the immediate impact would be even larger. The entire plan would raise gross domestic product by one percentage point in 2014, equivalent to about a $1,500 increase for each U.S. household. Ten years from now, at the end of the official budget horizon, we estimate that the entire plan would raise GDP by three percentage points, or more than $4,000 for each U.S. household.
Our assessment is based on a modern macroeconomic model (developed with Volker Wieland of the University of Frankfurt and Maik Wolters of the University of Kiel) whose features include a recognition that the resources to finance government expenditures aren't free—they withdraw resources from the private economy. The model provides for other essential attributes of the economy—that consumers, businesses and workers respond to incentives, and they are influenced by their expectation of future economic conditions when making decisions today. None of these features is provided for in old-style Keynesian models.
The House budget plan keeps total federal outlays at their current level for two years. Thereafter, spending would rise each year, but more slowly than if present policies continue. By 2023, federal expenditures would decline to 19.1% of GDP in 2023 from 22.2% today.
Since the Congressional Budget Office projects that revenues will equal 19.1% of GDP in 2023, the House plan will balance the budget that year. Also by 2023, the publicly held federal debt relative to GDP would decline to 55% from its current high level of 76%.
Read the full op-ed at the Wall Street Journal.