Economist Corner

A recent report by Moody’s Analytics that the Budget now before the House would cost 780,000 jobs. These claims are flagrantly wrong and misleading. The economics behind them are highly dubious.

For starters, the analysis reflects speculation about what Republicans will do, rather than the legislation put forward by Speaker McCarthy. “While not stipulated in the legislation, Republicans would likely work to exclude discretionary spending on defense and veterans’ benefits from the cuts,” according to the report, “putting the burden of the cuts on nondefense, non-VA discretionary programs.”  The results that follow are then based on this assumption. That means that the study is not the model of Speaker McCarthy’s legislation that many seem to think it is.

More generally, the Moody’s Analytics model is not known for its accuracy. It is based on a naïve and simplistic assumption that we live in a world of unlimited financial resources. This assumes that added government spending is “free” and does not involve any opportunity cost to the economy. In the current environment, however, there are more than 9 million job vacancies, budget deficits are spiraling, and the Federal Reserve is raising interest rates to contain inflation. In this environment, the assumption that resources are unlimited verges on the laughable.

The entire annual savings by the household sector and the retained earnings of the corporate sector amount to roughly $1.6 trillion (based on fourth quarter numbers). The US budget deficit in just the first six months of the fiscal year amounted to $1.1 trillion at an annual rate. Thus, at these rates, the deficit will consume more than the entire private savings of America’s households and firms. The economy must rely on foreigners to finance this deficit and the other investments made by America’s households and firms. To attract this money US interest rates must be higher than would otherwise be the case. These rates not only attract foreign money, but they also make investments by Americans more expensive.

Thus, the federal deficit is crowding out other investments. Lowering those deficits as the Speaker proposes does not cost GDP or jobs as the report alleges but shifts its composition away from federal spending toward such investments as home construction and business capital formation.

The Speaker’s plan cuts spending by roughly $4.5 trillion over ten years, including $3 trillion in discretionary cuts. That is sufficient to finance the construction of roughly 700,000 median priced new homes every year for the next ten years. This is equivalent to half of all new private housing starts. There are roughly 8 million workers in the US construction industry, residential and non-residential, and not all the $4.5 trillion will be spent on new construction. But whatever that money is invested in will be job creating. Even straightforward back-of-the-envelope calculations suggest that the $4.5 trillion freed up by the Speaker’s plan will produce more than the estimated 780,000 jobs that are allegedly lost.

In an economy at or near full employment with the Fed hiking rates the debate on the budget is not about “more” vs. “less” but about what the country will spend its scarce resources on. The decision comes down to whether that spending will be controlled by bureaucrats or by American households and firms. The Speaker’s proposal chooses the latter, the White House prefers the former.