GDP vs Spending: When is More, Less?

Commenter Tom argues that a chart in my recent post is flawed. Here’s the offender:

Tom writes:

Graph 2 is super noisy. Without 2008 and 2009 (off years by any measure), that trend line would be closer to verticle, (sic) and then even the strongest of correlation wouldn’t help the argument.

That statement raises several questions. First, what’s an “off year”? A recession? Should we only count good times? 2008 and 2009 were, by all indications, moderate recessions. Let’s not confuse the real economy with the stock market. Leaving them off wouldn’t change the trend line much; there would still be a strong negative correlation. In fact, if you adjusted 2008 and 2009 to discount the stimulating effects of TARP and the ARRA (which Dr. Yandle touched on in the presentation featuring this slide), than the correlation would be even stronger.

Second, why doesn’t this correlation matter? If you spend more than you earn, you run out of money. All the methods to escape debt, higher taxes, inflation, etc, are painful for citizens to live through. The question then becomes, are the short-term gains from spending equal or greater than the long-term costs? There are many philosophical arguments for or against any particular category of spending. However, given that many democrats are running against their own voting records, and that stimulus spending was apportioned with a partisan bias, I’d say no.

Writing in today’s Wall Street Journal, Art Laffer points out that income taxes have a negative correlation with economic growth.

In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51%, and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%.

Source: Wall Street Journal

If you think about it for a second, it’s easy to see who is hurt by these spending policies; the poorest states, which can least afford marginal losses in GSP. At best, it’s irresponsible for policy makers to ignore such correlations. At worst, it harms the most needy.

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6 Responses to GDP vs Spending: When is More, Less?

  1. Thomas Merrill says:

    Concerning the mechanics of this correlation: The last post stated that this correlation “indicates that spending cuts pay for themselves with a growing economy”. The graph above expresses spending as a share of GDP, and in a year like 2009, real GDP was lower than in the previous year, and so even a y/y decline in spending could be an increase in nominal spending as a share of nominal GDP. Leveraging the change in spending by dividing by the GDP to which spending is being compared does not accurately show the relationship between the two variables. No causation can be implied between government spending and GDP by this method.

    On the premise of the correlation: People and businesses run out of money when they spend more than they earn; governments do not — they pass the burden onto people and businesses for the decades that follow. Government spending one year-at-a-time cannot affect GDP one year-at-a-time. There are many more variables that need to be considered for longer-term trends as well, such as those described here:

    Overall, I think the problem is that spending decisions are made without questioning whether the short-term gains from spending are equal or greater than the long-term costs. Such consideration requires that decisions be made beyond the political life cycle of elected administrations.

  2. Thomas Merrill says:

    Nobody serious will ever imply that government spending or stimulus can take the place of private spending. Meanwhile, outlets with more rigorous statistics and less talking-point-rhetoric have also been concerned about fiscal policy:, and

    Most of the spending problems that are reaching crisis stage now are moving up from the local levels (education budgets, public employee pensions, etc) and stemming from decades of relative prosperity that has worn off. Each level of government in the heirarchy has different time periods over which burdens from spending (and benefits from progress) are equalized, and each higher level has a responsibility to serve as equalizer for the level below it — lest we end up with neighbors like Maine & Massachusetts developing a relationshop like Ireland to England during the potato famine.

  3. Aaron says:

    I wish the world wouldn’t take people like Krugman and Klein seriously, either, but there we are. That’s a relatively unsophisticated view of the way these problems ‘bubble up’. You make it sound like we have wise federal planners who have been patiently, waiting for the the local rubes imbecility to reach a boil before stepping in with what Soros calls sterile “fiscal rectitude”. In reality, much like Friedman said, “[n]othing is so permanent as a temporary government program.

    The argument in the post, and in the presentation, was that tax rates are a political sideshow. So yes, the talking points are short. There’s not much time on Capitol Hill with a lunch audience. Taxing the rich isn’t the way out of the problem, because it won’t do anything to revenue (except possibly time-shift, that is, steal from the future). And if you’re arguing for more time-shifting, than you’re ignoring two important points, like Japan’s lost decade, it will be harder on more people for longer, and growth takes time, which you’re willing to choke off. Those models didn’t make any sense in 2008, and they don’t make sense now.

    The point remains, taxes alone can’t level the debt. They’re a political sideshow. We absolutely need to cut spending, including politically challenging areas like Medicare, Medicaid, public employee costs (at the state and local level), defense, and healthcare. How we do that is another question. Arguing for more stimulus, when states and localities are already explicitly bankrupt, is akin to the Titanic band threatening to stop playing unless they get a subsidy from the people running for the lifeboats.

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