Fiscal Consolidation Strategy: An Update for the Budget
Reform Proposal of March 2013
Recently, we evaluated a fiscal consolidation strategy for the United States that would
bring the government budget into balance by gradually reducing government spending
relative to GDP to the ratio that prevailed prior to the crisis (Cogan et al, JEDC 2013).
Specifically, we published an analysis of the macroeconomic consequences of the 2013
Budget Resolution that was passed by the U.S. House of Representatives in March 2012. In
this note, we provide an update of our research that evaluates this year’s budget reform
proposal that is to be discussed and voted on in the House of Representative in March 2013.
Contrary to the views voiced by critics of fiscal consolidation, we show that such a reduction
in government purchases and transfer payments can increase GDP immediately and
permanently relative to a policy without spending restraint. Our research makes use of a
modern structural model of the economy that incorporates the long-standing essential features
of economics: opportunity costs, efficiency, foresight and incentives. GDP rises because
households take into account that spending restraint helps avoid future increases in tax rates.
Lower taxes imply less distorted incentives for work, investment and production relative to a
scenario without fiscal consolidation and lead to higher growth.