The question of how much of an impact $85 billion worth of cuts between March and September of this year might have can be answered in a variety of ways. To begin with, note that since we look at real GDP statistics in annualized terms (real income generated over a quarter times four basically) we should note that $85 billion over seven months is, on an annualized basis, equivalent to about $146 billion in cuts. Next, inasmuch as our focus should be on the impact on total earnings adjusted for inflation (real GDP), assuming that prices remain at the level they were at the very end of 2012 this means spending cuts at the federal level in real terms of about $126 billion (the GDP deflator for the fourth quarter was approximately 116). Note too that the $85 billion is just for the rest of fiscal year 2013 with still more cuts in spending on the way! (1) (2)
Last quarter real GDP was estimated to have been about $13.6 trillion (with an estimated total population of just a bit over 315 million this means real per capita income of about $43,175). Assuming that there are no multiplier effects taking 126 billion of income generating spending out of the economy will, all else equal, lead to about a 1% drop in real income or PER PERSON a decline in real income of about $400. With an expenditure multiplier of 2, double this figure for an average loss per American of about $800! Estimates can vary of course. One set of estimates I have -using data from the first quarter of 1995 to the third quarter of 2011- suggests that, controlling for increases in inflation-adjusted government spending at the state and local levels and increases in real economic investment,each billion cut to increases in real government spending at the federal level on average lowers absolute increases in real GDP by 0.016%. This means, on an annualized basis, sequestration cuts may, all else equal, shave as much as 2% (.016*126) off whatever increases in real income we might otherwise manage to achieve. Those who argue that the impact of such cuts are minimal have, as a matter of simple arithmetic, a challenge ahead of them unless they can argue either for a remarkably reliable and speedy supply-side adjustment to reduced demand or that households and businesses, so encouraged and relieved by decisive action by the federal government, set in motion a tremendous increase in private sector spending.
Absent such miracles the economy will suffer. And the fact is that regardless of the details, we are talking about averages and so, by definition, if there are some of us who may barely feel the effects of these cuts while others will feel their effects all the more acutely. If, for example half of a population of 315 million souls (congressional representatives, stock brokers, and college professors) emerge largely unscathed by these cuts and AVERAGE real income falls by $600 (I split the difference from the above numbers of $400 and $800 or in other words, assume an expenditure multiplier of 1.5) this means that the other half of the population suffers an average loss in real income of $1,200 a head! Far too often, principally because those of us looking at these issues are not the ones who end up bearing the brunt of cuts, we pay too little attention to how unevenly and unfairly the burden of adjustment is carried. It is far easier to focus on the potential long-run benefits of any action if one is not likely to bear much of the short-run costs.
Also note that what all this is based on the assumption that state and local spending will remain constant and that economic investment will do so as well. This is, to say the least, questionable. State and local government spending adjusted for inflation and measure per capita was, as of last quarter nearly 7.7% less than its most recent peak level of $5,103 per person in the third quarter of 2009. In short, in a time of economic distress state and local governments have cut their spending per person in real terms by over $480. Again largely overlooked economic investment has been increasing nicely in the last year (arguably thanks to the Fed's Operation Twist). While the coming cutbacks will free up resources that eventually could be used for still more private sector investment, is it sensible to assume that an entrepreneur would seriously consider adding to retail space in areas where a large number of federal employees are now working four days out of every five or that she would be giving much thought to increasing or modernizing her fleet of trucks to travel over roads that are increasingly in need of repair? It is possible but not probable.
Finally, there is the question of need. At the federal level, real spending per American hit a peak of $3518.90 in the third quarter of 2010 and, last quarter, continued the steady DOWNWARD trend it has been on since then to end up about $331 lower. While this helps to explain a certain part of the drop in the federal government's budget deficit, most of the decline of some 343.8 billion in real terms since 2009 is thanks to economic growth. (One figure in support of this is that federal receipts in real terms have increased -despite lower tax RATES- by over $200 billion between 2009 and 2012) If the budget deficit were to continue to fall, largely through economic growth, by as much as it did last year (some 200 billion) over the next two years it would "only" be some $100 billion higher than it was in 2008; a time when few of those now so concerned with its size seemed terribly worried about it.
Last quarter real GDP was estimated to have been about $13.6 trillion (with an estimated total population of just a bit over 315 million this means real per capita income of about $43,175). Assuming that there are no multiplier effects taking 126 billion of income generating spending out of the economy will, all else equal, lead to about a 1% drop in real income or PER PERSON a decline in real income of about $400. With an expenditure multiplier of 2, double this figure for an average loss per American of about $800! Estimates can vary of course. One set of estimates I have -using data from the first quarter of 1995 to the third quarter of 2011- suggests that, controlling for increases in inflation-adjusted government spending at the state and local levels and increases in real economic investment,each billion cut to increases in real government spending at the federal level on average lowers absolute increases in real GDP by 0.016%. This means, on an annualized basis, sequestration cuts may, all else equal, shave as much as 2% (.016*126) off whatever increases in real income we might otherwise manage to achieve. Those who argue that the impact of such cuts are minimal have, as a matter of simple arithmetic, a challenge ahead of them unless they can argue either for a remarkably reliable and speedy supply-side adjustment to reduced demand or that households and businesses, so encouraged and relieved by decisive action by the federal government, set in motion a tremendous increase in private sector spending.
Absent such miracles the economy will suffer. And the fact is that regardless of the details, we are talking about averages and so, by definition, if there are some of us who may barely feel the effects of these cuts while others will feel their effects all the more acutely. If, for example half of a population of 315 million souls (congressional representatives, stock brokers, and college professors) emerge largely unscathed by these cuts and AVERAGE real income falls by $600 (I split the difference from the above numbers of $400 and $800 or in other words, assume an expenditure multiplier of 1.5) this means that the other half of the population suffers an average loss in real income of $1,200 a head! Far too often, principally because those of us looking at these issues are not the ones who end up bearing the brunt of cuts, we pay too little attention to how unevenly and unfairly the burden of adjustment is carried. It is far easier to focus on the potential long-run benefits of any action if one is not likely to bear much of the short-run costs.
Also note that what all this is based on the assumption that state and local spending will remain constant and that economic investment will do so as well. This is, to say the least, questionable. State and local government spending adjusted for inflation and measure per capita was, as of last quarter nearly 7.7% less than its most recent peak level of $5,103 per person in the third quarter of 2009. In short, in a time of economic distress state and local governments have cut their spending per person in real terms by over $480. Again largely overlooked economic investment has been increasing nicely in the last year (arguably thanks to the Fed's Operation Twist). While the coming cutbacks will free up resources that eventually could be used for still more private sector investment, is it sensible to assume that an entrepreneur would seriously consider adding to retail space in areas where a large number of federal employees are now working four days out of every five or that she would be giving much thought to increasing or modernizing her fleet of trucks to travel over roads that are increasingly in need of repair? It is possible but not probable.
Finally, there is the question of need. At the federal level, real spending per American hit a peak of $3518.90 in the third quarter of 2010 and, last quarter, continued the steady DOWNWARD trend it has been on since then to end up about $331 lower. While this helps to explain a certain part of the drop in the federal government's budget deficit, most of the decline of some 343.8 billion in real terms since 2009 is thanks to economic growth. (One figure in support of this is that federal receipts in real terms have increased -despite lower tax RATES- by over $200 billion between 2009 and 2012) If the budget deficit were to continue to fall, largely through economic growth, by as much as it did last year (some 200 billion) over the next two years it would "only" be some $100 billion higher than it was in 2008; a time when few of those now so concerned with its size seemed terribly worried about it.
