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.
After World War II, the U.S. cut federal government spending dramatically. In 1945, federal government spending as a share of GDP peaked at 31.6%, and by 1948 it was down to 14.4%. Private real GDP (e.g., GDP less government purchases) for the three years 1946, 1947 and 1948 grew at a 7.5% annual rate. So much for the idea that cutting government spending hurts the economy.
President Clinton also cut federal government spending as a share of GDP by over four percentage points, to 18.8% in 2000 from 22.9% in 1992—more than the next four best presidents combined. We all remember the prosperity of Mr. Clinton’s eight years in office. I could go on and on, but the simple fact is that cutting government spending stimulates the economy. My fervent wish would be to have Mr. Obama be more like Mr. Clinton. As it stands now, they couldn’t be more diametrically opposed.