Arthur Laffer Explains the Debt Ceiling and Spending

You’ve already heard about White House economic advisor Austan Goolsbee predicting economic catastrophe if lawmakers don’t raise the debt ceiling beyond the $14.whatever trillion amount it’s at today. And you’ve also heard that in 2006 President Obama, as a Senator, voted against raising the debt ceiling. (He called it a “leadership failure.” Go figure.) Arthur Laffer argues that the Republicans, if they do vote to raise the debt ceiling, should demand some strict concessions when it comes to spending. He also makes the case that raising the debt ceiling isn’t necessary.

But just because the debt ceiling should be raised on this occasion does not mean that the logic behind Mr. Goolsbee’s argument—that not doing so would be “catastrophic” for the economy—is accurate. On the contrary, cutting spending and cutting it drastically would not hurt the economy. It would, in fact, help the economy, even if done now.

Imagine there are only two farmers who make up the whole economy—Farmer Jones and Farmer Smith. If Farmer Smith receives unemployment benefits, who do you think pays for those unemployment benefits? Farmer Jones is the correct answer.

Government spending is taxation, pure and simple. That taxation reduces output, employment and production. It’s basic Econ 101. If, instead of using government spending for productive purposes, Congress uses it on bailouts for failing banks and unprofitable businesses, cash for clunkers, housing subsidies and unemployment, it’s a double-whammy for the economy. You can’t raise taxes on people who work, increase what you pay people not to work, and then expect more people to work.

The mistake Mr. Goolsbee makes when he says that a massive reduction in government spending will reduce output is to confuse accounting with economics. In the simplest accounting terms, GDP is equal to consumption plus investment plus government spending—that’s true. But reducing government spending doesn’t reduce GDP dollar-for-dollar, as this accounting equation would seem to be saying.

Reducing government spending is not only a reduction in one of the components of GDP, but it is also a reduction in effective taxation and a reduction in payments for non-work and less output. In due course, cutting government spending will increase private output (in this case consumption plus investment) by more than the reduction in government spending.

Read the whole thing. Laffer makes perfect sense. The problem is that we’re now at the point where the Farmer Smith’s nearly outnumber the Farmer Jones’s. Unfortunately, our political leaders know this. And they’re banking on the Farmer Smiths’ and enough guilty feeling Farmer Jones’s to get out to the polls in the next election. To hell with the consequences.